The following three tech stocks are not only market leaders in their respective fields but also have been around for decades, have high profitability measures and, most importantly, trade cheaply. Very cheaply. These icons belong to a group of highly innovative companies, that are currently neglected by the market as general uncertainties about the economic outlook punish stocks across all sectors without regard for a differentiated analysis. I rate all of these 3 stocks a BUY based on their screaming undervaluation based on profitability, EPS growth rates and intrinsic value estimate. In fact, I consider these 3 companies to be interesting core holdings of long-term oriented investors and would even prefer them over Hewlett-Packard (HPQ), Google (GOOG), Apple (AAPL) and IBM (IBM).
Microsoft (MSFT) probably does not even need to be introduced in great detail. The company is a constituent of the S&P 500 and has a market cap of $247 billion. What I particularly like about Microsoft is not only its cheap valuation at only 9.5x earnings but also where the valuation comes from. Microsoft has over $7 per share in cash and a book value of $8.17 per share. As a result, about 25% of the current market assigned valuation of Microsoft is currently derived solely from its cash position (based on a current quote of $30 a share).
If investors look at the profitability of the company, they will find truly outstanding results: EPS growth this year of 28%, return on equity of 38% and a gross margin of 77%. These are astounding figures and I have yet to find another company that posts this impressive results. I am convinced, that the economic success of the company justifies a premium multiple of 20.
With an EPS estimate of $3.30 and a conservative multiple of 15, the stock would have an intrinsic value of $50 even though the performance of the company would justify an even higher valuation. Microsoft is an interesting value buy for investors who also value growth. The current prices offer a significant margin of safety.
Another tech play that is ridiculously undervalued is Intel (INTC) -currently trading at a single digit P/E ratio of 9.6. The company designs, manufactures and sells integrated digital technology platforms and is a major player in the semiconductor business. AMD (AMD) is its main competitor in the United States.
The stock has been trading quite weakly in the last couple of month: The stock is down about 10% over the quarter despite having strong operating results. Again, I attribute this decline to the general weakness in the equity markets rather than a pointed avoidance of Intel stock. In fact, savvy investors should pick up Intel on the cheap.
The return on equity stands at 27%, the net profit margin at 23%. About 10% of Intel's equity valuation is secured by its cash position of $2.73 per share. Given these outstanding key performance indicators, I would suggest a multiple of 20 to be more appropriate to capture Intel's innovative strength and market-leading product pipeline.
Analysts estimate a 2013 EPS of $2.64. The application of a conservative multiple of 15 would yield an intrinsic value for Intel of $39.6 which represents about 57% upside. The current assigned multiple of 9.6x massively discounts Intel's underlying profitability.
Technically, the stock sits at a crucial level: At $25 the stock has previously build a bottom. It is also where the lower bound of the short-term trend canal lies: An increase over the $25.50 mark proves the short-term strength of the support level, an increase above $27 would support the longer-term upward trend and render the short-term trend canal meaningless.
The third tech play, and the most undervalued based on its earnings prospects, is DELL Inc. (DELL). The company offers technology solutions and acts as a manufacturer of desktop and mobile computers, tablets and other electronic equipment for the IT hardware landscape. Dell has a market capitalization of $20 billion and revenues of $61.5 billion.
The undervaluation of Dell becomes apparent as investors look at its economic success: EPS has grown 40% y-o-y, the return on equity stands at 36% and the gross margin at 22%. Considering the competitive nature of the manufacturing business ,particularly in Asia, these are really good results in my opinion.
Stifel Nikolaus rated Dell a BUY with a price target of $18 at the end of May. From current share levels of $12 the company has 50% based on Stifel's research and valuation.
Analysts estimate a 2013 average EPS of $2.03. Even the application of a conservative multiple, that discounts Dell's true earnings power, of 15 would yield a substantially higher intrinsic value: $30.45. Since EPS is expected to increase y-o-y, there is no justifiable reason for a current P/E of 6 which translates into an earnings yield of 17%.
Chartists may find Dell also interesting: The chart depicts a huge gap of $2 just below the $15 share price mark. Gap theorists might want to initiate a long position in anticipation of a close of such gap. Both technically and fundamentally, I find Dell the most attractive of the tech stocks mentioned and attribute it the greatest risk/reward ratio.
Disclosure: I am long MSFT.