* All data are as of the close of Friday, December 12, 2014. Emphasis is on company fundamentals and financial data rather than commentary.
In the technology sector, bigger is not necessarily better. Rather, ingenuity and uniqueness can sometimes propel a smaller company forward in ways that make its larger competitors' jaws drop open.
The Diversified Computer Systems industry teaches us precisely that, as we see a small but highly evolved tech rodent taking on a colossal but antiquated tech dinosaur and outperforming it remarkably. And it's all because of the rodent's place in the technology tree, on a branch called "big data."
Just what is big data, anyway? Dictionary.com defines it as:
Data sets, typically consisting of billions or trillions of records, that are so vast and complex that they require new and powerful computational resources to process.
These new "computational resources" required to collect, store and process big data are very much in demand at the moment and will be so for years to come, as social media companies and online retailers (just to mention two communities) are continually amassing greater and greater collections of data on their members and shoppers, and are needy of fast and efficient ways of handling it all. Biotechnology companies, especially those dealing with human and animal genomes, are also in great need of such data-crunching technology.
So when a small upstart like the third largest company in the Diversified Computer Systems industry - Cray Inc. (NASDAQ: CRAY) - comes up with equipment and software that is especially designed for bid data, you can be sure its stock will be in just as much demand as its products and services, as noted in the graph below.
The company has enjoyed exceptional demand for its high-performance computing (HPC) systems, supercomputing systems, data discovery appliances for large and irregular data mining problems, storage and data management solutions, and flexible storage and archiving solutions that allow users to transparently move data among fast, primary, and archival tiers, in addition to offering custom engineering solutions for specialized applications.
Yet the gargantuans of the technology world are sometimes hampered by their size, as steering an established company in a new direction can be cumbersome. Sure, these giants have a great deal of cash they can throw at a new venture. But they have one very crucial disadvantage… they are already known for other things, and shaping a new image can sometimes be more difficult than shaping a new company division itself.
This is one reason why the largest company in the Diversified Computer Systems industry - Hewlett-Packard Company (NYSE:HPQ) - has been stagnating. In a world where new technologies are appearing everywhere with great consumer and corporate reception, HP has been struggling to make inroads into any of them, and its stock has suffered for it.
Yet HP is slowly but surely branching out and broadening its array of products and services, which now include: personal computers, workstations, tablets, retail point-of-sale (POS) systems, calculators and other related accessories, software for the commercial and consumer markets, printer hardware and supplies, media and Web services, scanning devices, ink-jet and laser-jet printing solutions, and graphics solutions. It has also established itself as a reputable provider of business systems, traditional and converged storage solutions, networking products comprising controllers/switches, routers, and wireless LAN access points, and technology consulting and support services focused on cloud, mobility, and data.
So, yes, HP is dipping its toes into the big data pool. But can it catch up to its smaller competitors?
The middle member of the three largest Diversified Computer Systems companies - Diebold, Incorporated (NYSE: DBD) - has been stagnating as well, most likely due to its highly focused and narrow field of operation.
The company primarily offers self-service delivery and security systems to the financial, commercial, retail, and other markets, including automated teller machine (ATM) outsourcing, ATM security, deposit automation, recycling and payment terminals, and software. It also provides outsourced and managed services such as remote monitoring, troubleshooting for self-service customers, transaction processing, currency management, maintenance services, online communication services, security solutions which include physical security products for drive-up lanes, vaults, safes, depositories, bullet-resistive items, under-counter equipment, electronic security products such as camera and video surveillance equipment, alarms, access control systems, biometric technologies, and security monitoring solutions comprising remote monitoring and diagnostics, fire detection, intrusion protection, managed access control, energy management, remote video management and storage, logical security, and Web-based solutions. Additionally, it offers strategic analysis and planning of new systems, architectural engineering, consulting, elections and lottery equipment, networking, tabulation, and diagnostic software.
Plotting the three stocks on a graph clearly shows where all the action is in the tech space these days, as depicted below. Since the economic recovery began in early 2009, where the broader market S&P 500 index [black] has gained some 195% and the SPDR Technology Sector ETF (NYSE: XLK) [blue] has gained 208%, HP [beige] and Diebold [purple] have been unable to keep pace with either of the benchmarks, rising a mere 50% and 80% respectively. But to find Cray's stock [orange] you'll have to look up, way up, as it has skyrocketed an amazing 1,350%.
On an annualized basis, where the S&P has averaged 33.91% and the XLK has averaged 36.17%, HP has averaged 8.70%, Diebold has averaged 13.91%, while Cray has averaged a big data figure of 234.78% per year!
Looking forward, after a shaky current quarter, the Diversified Computer Systems industry's earnings are expected to outgrow the broader market's average earnings growth rate consistently for years to come, as tabled below where green indicates outperformance while yellow denotes underperformance.
After underperforming significantly this quarter, the industry is expected to outgrow the broader market's average earnings at some 1.77 times the market's rate next quarter, 2.53 times in 2015, and 1.65 times annually over the next five years.
Zooming-in a little closer, the three largest companies in the space are expected to split perform in earnings growth much like their stocks have, as tabled below.
Size is expected to have a definite impact over the current quarter, where all three companies underperform the broader market relative to their size, with HP suffering the least while both Diebold and Cray shrink, with Cray shrinking more.
But come 2015 and beyond, Cray's small size and hot demand are expected to boost its earnings far above the rest, outgrowing the broader market at some 7.22 times its rate, before slowing to a more sustainable but still market leading 2.16 times annually over the next five years.
Yet there is more than earnings growth to consider when sizing up a company as a potential investment. How do the three compare against one another in other metrics, and which makes the best investment?
Let's answer that by comparing their company fundamentals using the following format: a) financial comparisons, b) estimates and analyst recommendations, and c) rankings with accompanying data table. As we compare each metric, the best performing company will be shaded green while the worst performing will be shaded yellow, which will later be tallied for the final ranking.
A) Financial Comparisons
• Market Capitalization: While company size does not necessarily imply an advantage and is thus not ranked, it is important as a denominator against which other financial data will be compared for ranking.
• Growth: Since revenues and expenses can vary greatly from one season to another, growth is measured on a year-over-year quarterly basis, where Q1 of this year is compared to Q1 of the previous year, for example.
In the most recently reported quarter, Cray delivered the greatest revenue growth year-over-year, where HP delivered the least, even shrinkage.
Since both Diebold's and Cray's year-over-year earnings growth are not available, the metric does not factor into the comparison, though it is worth noting that HP suffered shrinkage here too.
• Profitability: A company's margins are important in determining how much profit the company generates from its sales. Operating margin indicates the percentage earned after operating costs, such as labor, materials, and overhead. Profit margin indicates the profit left over after operating costs plus all other costs, including debt, interest, taxes and depreciation.
Of our three contestants, Cray operated with the widest profit margins while HP enjoyed the widest operating margins. At the narrow end of the scale, Diebold and Cray split the narrowest margins between them.
• Management Effectiveness: Shareholders are keenly interested in management's ability to do more with what has been given to it. Management's effectiveness is measured by the returns generated from the assets under its control, and from the equity invested into the company by shareholders.
For their managerial performance, HP's management team delivered the greatest returns on assets and equity, where Cray's and Diebold's teams split the worst returns between them.
• Earnings Per Share: Of all the metrics measuring a company's income, earnings per share is probably the most meaningful to shareholders, as this represents the value that the company is adding to each share outstanding. Since the number of shares outstanding varies from company to company, I prefer to convert EPS into a percentage of the current stock price to better determine where an investment could gain the most value.
Of the three companies here compared, HP provides common stock holders with the greatest diluted earnings per share gain as a percentage of its current share price, while Diebold's DEPS over current stock price is lowest.
• Share Price Value: Even if a company outperforms its peers on all the above metrics, however, investors may still shy away from its stock if its price is already trading too high. This is where the stock price relative to forward earnings and company book value come under scrutiny, as well as the stock price relative to earnings relative to earnings growth, known as the PEG ratio. Lower ratios indicate the stock price is currently trading at a cheaper price than its peers, and might thus be a bargain.
Among our three combatants, HP's stock is cheapest relative to forward earnings and company book value, while Diebold's is cheapest relative to 5-year PEG. At the overpriced end of the spectrum, Cray's stock is the most overvalued overall.
B) Estimates and Analyst Recommendations
Of course, no matter how skilled we perceive ourselves to be at gauging a stock's prospects as an investment, we'd be wise to at least consider what professional analysts and the companies themselves are projecting - including estimated future earnings per share and the growth rate of those earnings, stock price targets, and buy/sell recommendations.
• Earnings Estimates: To properly compare estimated future earnings per share across multiple companies, we would need to convert them into a percentage of their stocks' current prices.
Of our three specimens, Cray offers the highest percentage of earnings over current stock price for the current quarter, while HP offers it for all other time periods. At the low end of the scale, where Diebold offers the lowest percentage for the current quarter, Cray offers it going forward.
• Earnings Growth: For long-term investors this metric is one of the most important to consider, as it denotes the percentage by which earnings are expected to grow or shrink as compared to earnings from corresponding periods a year prior.
For earnings growth, HP offers the greatest earnings growth in the current quarter, Diebold offers it next quarter, while Cray offers it in 2015 and beyond. At the low end of the scale, Cray offers the least growth near term where HP offers it longer term.
• Price Targets: Like earnings estimates above, a company's stock price targets must also be converted into a percentage of its current price to properly compare multiple companies.
For their high, mean and low price targets over the coming 12 months, analysts believe Cray's stock offers the least upside potential and least downside risk, while Diebold's stock offers the greatest upside and HP's offers the greatest downside.
It must be noted, however, that Cray's stock is already trading below its low target. While this may mean increased potential for a sharp move upward, it may warrant a reassessment of future expectations.
• Buy/Sell Recommendations: After all is said and done, perhaps the one gauge that sums it all up are analyst recommendations. These have been converted into the percentage of analysts recommending each level. However, I factor only the strong buy and buy recommendations into the ranking. Hold, underperform and sell recommendations are not ranked since they are determined after determining the winners of the strong buy and buy categories, and would only be negating those winners of their duly earned titles.
Of our three contenders, Cray is best recommended with 1 strong buy and 3 buys representing a combined 100% of its 4 analysts, followed by HP with 6 strong buy and 8 buy ratings representing 45.16% of its 31 analysts, and lastly by Diebold with 0 strong buy and 1 buy recommendation representing 16.67% of its 6 analysts.
Having crunched all the numbers and compared all the projections, the time has come to tally up the wins and losses and rank our three competitors against one another.
In the table below you will find all of the data considered above plus a few others not reviewed. Here is where using a company's market cap as a denominator comes into play, as much of the data in the table has been converted into a percentage of market cap for a fair comparison.
The first and last placed companies are shaded. We then add together each company's finishes to determine its overall ranking, with first place finishes counting as merits while last place finishes count as demerits.
And the winner is… HP, proving once again that strong financial fundamentals beat hot markets any day, outperforming in 14 metrics and underperforming in 6 for a net score of +8, followed far behind by both Diebold and Cray in a tie with net scores of -4.
Today's competition illustrates the difficult choice investors are often faced with: go with the company whose stock is hottest, or go with the one with the sounder fundamentals. There is a way through this dilemma, though, as some investors will simply opt for both, splitting their allocation according to the amount of risk they are willing to take. That's the saving grace of investing - you don't have to chose just one, but can always incorporate a little of each.
Where the Diversified Computer Systems industry is expected to underperform the S&P broader market significantly this quarter, then outperform significantly next quarter, in 2015 and beyond, the three largest companies in the space (all U.S.-based) are expected to under-grow their earnings relative to the broader market near term - where the colossal HP remains on the lower side of the market's growth rate while the others readily outperform, with big data player Cray leading the way in growth for years to come.
Yet after taking all company fundamentals into account, Hewlett-Packard Company computes the soundest financial stats overall, given its lowest stock price to forward earnings and company book, highest cash and revenue over market cap, widest operating margin, highest returns on assets and equity, highest EBITDA over market cap and revenue, highest diluted earnings over current stock price, highest future earnings over current stock price overall, and highest future earnings growth in the current quarter - decisively winning the Diversified Computer Systems industry competition.