4 Cheap Tech Stocks

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Have you seen some of these numbers?

Google (Nasdaq: GOOG  ) trades at 12 times forward earnings, and cash makes up a quarter of its market cap. It's expected to grow more than 17% annually for the next five years, after growing more than 25% per year over the past five. Shares trade lower today than they did in 2006.

Microsoft (Nasdaq: MSFT  ) trades at 8.7 times forward earnings and less than 10 times trailing earnings -- a third lower than the market average. The company is expected to grow 10.3% for the next five years and throws off enough free cash flow to pay a 12% dividend. Cash makes up more than a fifth of its market cap.

Hewlett-Packard (NYSE: HPQ  ) is in sorrier shape. Shares trade at all of 6.5 times forward earnings, implying the company will not only never grow again, but shrink. Oddly, average analyst estimates call for 9.2% growth over the next five years, and current earnings are easily at an all-time high. If HP took the cash it generated last year and paid it out as a dividend, the yield at today's prices would be nearly 13% -- almost five times the current yield on Treasury bonds.

No love for Apple (Nasdaq: AAPL  ) either. With the cult-like excitement around Apple's success, you'd think it'd be priced for perfection. Not the case. Shares trade at 11 times forward earnings, or 15 times trailing earnings, which is barely on par with the market average. Cash in the bank makes up more than 10% of market cap, and the company spins off enough cash to potentially pay an 8% dividend. And those cash flows are growing at about 20% annually, mind you.

What's going on?

Some say companies like Microsoft and HP trade where they do because they are dinosaurs being overrun by competition. But the argument is hard to buy, since Google and Apple -- two of the strongest, fastest-growing companies in the market that dominate their industries -- trade at similar valuations. Something else must be to blame.

One idea is that investors are becoming resigned to the fickle nature of technology. All industries change over time, but nowhere is there more upheaval than technology. Take Research In Motion (Nasdaq: RIMM  ) . A few years ago, the company's future looked so bright. Then came the iPhone and ... snap ... market share plunged, and shares fell more than 80%.

Could something similar happen to, say, Google or Apple? Crazier ideas have been proposed. Author Nassim Taleb outlined the risk in his book The Black Swan:

At no time in history has a company grown so dominant so quickly -- Google can service people from Nicaragua to southwestern Mongolia to the American West Coast, without having to worry about phone operators, shipping, delivery, and manufacturing. This is the ultimate winner-take-all case study.

People forget, though, that before Google, Alta Vista dominated the search-engine market. The Web causes something in addition to concentration ... [it] enables the formation of a reservoir of proto-Googles waiting in the background. It also promotes the inverse Google, that is, it allows people with a technical specialty to find a small, stable, audience.

Note that this isn't a forecast. It's just a nod to capitalism's "creative destruction" tendencies -- particularly in fairly new industries. Things change quickly, and investors have to price in that risk.

There could be something else holding shares back. Most large tech companies don't have the greatest dividend policies. Of these four tech companies, Google and Apple pay no dividends at all, HP's is wholly inadequate, and Microsoft's should be considerably higher. All could comfortably afford to pay dividends that would yield more than 5%. And there's every reason to believe that doing so would lift shares to more reasonable valuation multiples. As I wrote last month, slow-growing companies like utilities and telecoms actually trade at higher earnings multiples than some of the fastest-growing tech companies. Why? One of the only explanations is that slow-growing utilities pay large dividends, and tech companies don't. In a world where investors are disenchanted with capital appreciation yet starving for yield, this is hardly surprising.

Both of these reasons -- high change and low dividends -- might explain why shares are cheap, but they don't justify it. Not at these levels. Not this cheap. In the end, the best explanation for why tech stocks are cheap might be the simplest: The market has gone mad. And if you're looking for opportunity, that's the most welcome explanation there is.

Fool contributor Morgan Housel owns shares of Microsoft. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Google, Apple, and Microsoft. Motley Fool newsletter services have recommended buying shares of Apple, Microsoft, and Google. Motley Fool newsletter services have recommended creating a diagonal call position in Microsoft. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (9) | Recommend This Article (37)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 20, 2011, at 12:50 PM, CPACAPitalist wrote:

    I like MSFT personally, they aren't the coolest sexiest tech play, but they have the most attractive cash stockpile and dividend policy out of the four companies discussed.

    As far as tech volitiliy being a concern, I believe that is true for some investors, but for me that is akin to saying you should stay out of oil stocks because you never know when portable nuclear fusion (ala Dr. Emmit Brown) is going to come on the scene. These companies have a lot more diversity than the RIMM's of yester-year.

  • Report this Comment On June 20, 2011, at 1:19 PM, financeguy85 wrote:

    Right on Morgan. Tech is definitely cheap, and I totally agree on the argument for dividends. I would add INTC to this list. Yield is approaching 4 percent with fantastic fundamentals and dividend growth. Absurd.

  • Report this Comment On June 20, 2011, at 2:11 PM, chris12tom wrote:

    Nice read. GOOG is especially undervalued at this point. It has a PEG of .75 and they seem get beat down a lot for spending on R&D and hiring. If I'm not mistaken, R&D is what most tech companies should invest in. Nice read on it below:

  • Report this Comment On June 20, 2011, at 2:39 PM, bjasleep wrote:

    Trend is your friend. I am waiting for google to drop to ~450 before buying.

  • Report this Comment On June 20, 2011, at 4:24 PM, Joulesh wrote:

    The only one of those companies I would own is google. If Steve Jobs health deteriorates further, apple will drop. I also do not think Apple can compete with Android and with Google's Cloud. They also lost one of their great execs who pioneered their retail setup to JC Penney. MSFT needs a new CEO. They have lots of money and don't know what to do with it. They are losing PC dominance and they failed to capitalize on the phone/tablet revolution. They also continue to underwhelm technologically. Google has shown an ability to invest capital in diverse areas and generate good returns and they continue to be a technological leader. Most of the risk that I see in the other companies, like Apple and Microsoft, is FROM Google. I hope Google continues to drop so I can pick some up, although it is really cheap already. It's dropped so much that it's probably the least riskiest buy right now. Tech will always be risky because companies must continue to innovate to stay relevant and there is huge competition. No one can predict what the iphone 5 will be like, or even when it will come out, or what the next great android phone will be, or who will make the best tablet next year and what if google comes out with their own OS? You are far safer owning a stock in another sector with a business model that you understand. Young people think they understand technology, and they do, but tech stocks are still risky.

  • Report this Comment On June 20, 2011, at 5:27 PM, Borbality wrote:


    I am down quite a bit on GOOG but might buy more if it stays there long enough.

    Some good timing could lead to an easy 20-30% rise on that one, I think.

  • Report this Comment On June 20, 2011, at 9:59 PM, kcsag wrote:


    I have read a few of your posts in the past and looked at the charts that provide you with a comparative assessment of the entire sector. It should go without saying that based your charts, solar stocks are well priced currently.

    The only question I have is where do you get your numbers from?

    Thanks in advance

  • Report this Comment On June 21, 2011, at 6:51 AM, joaquingrech wrote:

    Good article. I missed more real analysis as to why they are trading the way they do.

    Some ideas:

    Google: they are projected to grow but their expenses are also growing dramatically. They are hiring many many people and spending tons of money on R&D. The issue is that it does not seem that these investments in r&d and human capital are paying off. That might explain the downward trend.

    Apple: it was priced for perfection. Now it is not. Issues might be because of the ipad and ipad2, they can't sell more because they simple don't have them. There was a huge manufactoring shortage and if you tried to get one you simply had ot wait weeks or months. It seems most analyst are expecting it to miss estimates this time. Also the treat of Android and Microsoft is keeping people doubing if the projected growth figures are really sustainable.

    Microsoft: Similar thing. You could compare it with RIMM. What happens if most people moves to apple or androids and drop ms systems? MSFT wouldn't be the dominant player anymore. From my point of view what doesnt make sense is that all 3 companies are down. At least one (or all) will be winners, but you can't have 3 losers at this point.

    HP: no clue. I guess people is worrying that tablets will eat marketshare, but in honesty, I don't know much about HPQ situation.

  • Report this Comment On June 21, 2011, at 1:12 PM, EquityBull wrote:

    Just a moment in time where Mr. Market is making you an offer (an irrational one for him). One can choose to take advantage of his gift today or ignore his offer. For those who ignore I predict in both 1, 2 and 3 years those who do not accept his offer on any of these 4 stocks (apple more then the others as it has the top growth, balance sheet and ROIC) will regret ignoring Mr. Markets irrational offers here today.

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