What follows is a list of technology companies the cover a variety of industries: semiconductors, telecom equipment, and software. Of the three, I find the strongest upside for Microsoft (MSFT) due to the unreasonable gap between how investors view it against Apple (AAPL). As I will explain, Microsoft also has the strongest brand and is well diversified in a way that can best unlock synergistic value. Investors who get in before the cloud computing era fully materializes will see significant gains from investing in Microsoft now.
To be sure, all of these technology companies will benefit from the nearing full recovery inflection point. However, some have diversified better than others. Microsoft has the best diversification in the sector, which it enables to accretively cross-sell multiple segments. Intel (INTC) and Qualcomm (QCOM), however, exist in much smaller areas of the sector and thus do not have this cross-selling advantage. The era of cloud computing, in particular, will preferentially benefit those who can leverage multiple core capabilities into a coherent unified offering.
Intel trades at a respective 11.6x and 10.6x past and forward earnings with a dividend yield of 3%. Consensus estimates for Intel's EPS forecast that it will grow by 1.3% to $2.42 in 2012 and then by 8.3% and 9.2% in the following two years. Assuming a multiple of 14x and a conservative 2013 EPS of $2.58, the stock would hit $36.12, implying 30.1% upside.
I believe that investors will increasingly look to the company as a safe dividend play. The combination of low multiples and attractive dividends makes the risk / reward particularly attractive. Free cash flow is also well prepared for maximization as processor inventories fall to boost margins.
Qualcomm trades at a respective 24x and 15.9x past and forward earnings with a dividend yield of 1.5%. Consensus estimates for Qualcomm's EPS forecast that it will grow by 17.5% to $3.76 in 2012 and then by 11.2% and 12.2% in the following two years. Assuming a multiple of 14x and a conservative 2013 EPS of $4.15, the stock would hit $58.10, implying 12.6% downside.
The lack of favorable reward is reinforced by DCF model. In it, I assume revenue growing 15.5% annually over the next half decade or so and operating metrics performing in-line with the recent historical 3-year average. Taxes are estimated at 33%. Taking a perpetual growth rate of 3% and discounting backwards by a WACC of 9% yields a fair value figure of just $66.33. Better risk / reward can surely be found elsewhere…
Microsoft trades at a respective 11.3x and 10.3x past and forward earnings with a dividend yield of 2.6%. Consensus estimates for Microsoft's EPS forecast that it will hold steady at $2.69 in 2012 and then grow by 11.9% and 10.6% in the following two years. Assuming a multiple of 14x and a conservative 2013 EPS of $2.97, the stock would hit $41.58 for 33.7% upside.
As attractive as these multiples are, they are even more attractive in light of the fact that the company is only valued at 44% of Apple's market cap. Yes, Apple is an amazing company, but Microsoft is, in my view, less about hype and more about impressive fundamentals. I believe that any miss in the assumptions that justifies Apple market value - which are aggressive as I explain here - will cause a meaningful shift towards Microsoft. The company has core strengths on the Internet, computing, and is enhancing this through a Nokia (NOK) partnership in mobile. As Microsoft positions these core strengths under a coherent unified platform, it is well positioned to gain.
Disclaimer: The distributor of this research report is not a licensed investment adviser or broker-dealer. Investors are cautioned to perform their own due diligence. We seek business relationships with all of the firms in our coverage, but research covered in this note is independent.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.