No technology? Ever?

It’s no secret that Warren Buffett avoids technology stocks, saying he prefers to invest in businesses he can understand. While nobody can argue with his success, is General Electric (GE) (300,000+ employees, 325 mergers/acquisitions in the 1990s) any less complicated than Intel (INTC)? Regardless of the reasoning, technology companies have come a long way, and many are no longer upstarts. In fact, four out of the 30 DJIA component stocks are technology companies: Intel, Microsoft, Hewlett-Packard and IBM. Over the last 15 years, the first two have matured and become very well respected members of the corporate establishment. Is it possible there could be a value stock lurking in their midst? Let’s take a look.

The fabulous four

For the analysis, I was tempted to choose the four DJIA technology stocks. Instead, I decided to swap IBM (IBM) with Cisco Systems (CSCO), primarily because IBM’s business has changed significantly during the last few years and besides, IBM has been around for nearly 100 years (1910). Based on its age (founded in 1939), I was also tempted to swap Hewlett-Packard (HPQ) with Dell Computer (DELL), but decided to leave HPQ on the list since they have a broader reach into peripherals and they’re about twice the size of Dell. Some other thoughts:

Why are we so excited?

My recent analysis comparing Apple Inc. (AAPL) to a microcap stock, Air T, Inc. (AIRT), has definitely drawn the ire of Apple fanatics because the analysis leads me to believe AAPL is priced at or somewhat above its intrinsic value. In saying this, I’m focusing strictly on earnings and basing this on: (1) it will be extremely challenging for AAPL to grow earnings at 20% annually for the next 10 years, and (2) AAPL's on a major product development treadmill. In that analysis, I focused strictly on quantitative considerations. In this post I’m going to look at some of the more qualitative aspects of Apple’s business.

Intrinsic value in action

To better help us understand Intrinsic Value, let's look at two completely different companies. Both are making money and doing fairly well. One is well known and one is not. The first one is Apple Inc (AAPL). The second one, Air T (AIRT), is a small ($70 million in annual sales) company that focuses on regional delivery of airfreight and aircraft servicing equipment (such as deicing and catering lifts). For simplicity, we are not going to look at their balance sheets. Instead, we are only going to focus on earnings. To summarize their earnings picture:

• Apple's 2007 earnings increased by 71% ($4.04/share vs. $2.36/share in 2006); trailing 12-month earnings are $4.56/share (see conference call transcript)
• Air T's 2007 earnings increased by 22% ($.94/share vs. $.77/share in 2006); trailing 12 month earnings are $1.29/share

If we were to take these numbers and extrapolate them for the next 10 years, AAPL would have earnings of $567.57/share and AIRT would be earning $7.72/share. This is probably not realistic, especially for Apple--just consider how many computers and iPods have already been sold.

What a month it was - for the stocks I cover/own and even more so for Mr. Market. Due in large part to the difficulties with the mortgage industry, markets remain in a quandary, trying to assess the fallout. The uncertainty of confusing news is such that recently it has seemed to take Mr. Market a day or more to fully digest the latest developments. At the end of last week, he was trying to understand the resilience of a troubled bond insurer when surprise employment and consumer confidence data, both negative, were reported. Mr. Market was in a good mood at the end of the day, having brushed aside these key indicators.

The following articles discuss stocks mentioned in this post:

There are quite a few well-known brands in the U.S. food industry yet few have managed to survive for over 100 years. One example is J.M. Smucker’s (SJM). Another well-known centenarian is Tootsie Roll (TR). In some ways the similarities are remarkable:

(1) TR was started in 1896 and SJM began making jams/jellies in 1897;

Early on, Warren Buffett took control of a small New England textile mill that became the namesake for his new company. Since then the company bearing the mill’s name, Berkshire Hathaway (BRK.A) (BRK.B), has witnessed incredible growth because of its ability to invest effectively. With a market capitalization in excess of $220 billion, Berkshire Hathaway no longer buys small companies. What if they did? Perhaps they would invest in microcaps, but which ones?

Tough Hurdle

Several months back, Barron’s featured an article on J.M. Smucker (NYSE: SJM). The article highlighted the company as a solid opportunity, intimating it might be a good defensive play. I thought it would be useful to evaluate SJM through our value investor lens and also to compare it to its much larger Ohio-based neighbor, P&G (NYSE: PG). Keep in mind that SJM's annual revenue is $2 billion vs. $76 billion for P&G. Nevertheless, I thought it would be interesting to compare these two companies as defensive plays. In keeping with our value investing approach, let's look at SJM as if we were buying it by starting with our 5-criteria filter:

(1) Straightforward business, preferably with a repeat purchase model: Definitely; J.M. Smucker is in the food products group. Chances are you're already using their products (JIF peanut butter, Crisco shortening/cooking oil, J.M. Smucker jam and jelly, Pillsbury baking ingredients, PET evaporated milk, etc.). Their business is geographically focused, as well--sales of their products are focused on the US and Canada.

One potential value stock is Arkansas Best (ABFS: NYSE). The stock has been driven down recently by two forces: a slowing economy (lower traffic growth) and rising fuel prices (higher costs).