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Oracle Corporation
Oracle Research Conclusions

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By cathrone
May 28, 2002

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In this post I hope to summarize my research and come to some conclusion as to what I want to do regarding Oracle.

I am struggling a little bit on how to form all of my research into one final conclusion about the company. For now, I decided to assign a grade to each of the four areas related to the company (strengths, weaknesses, financials, and maintaining strengths and overcoming weaknesses). I'll average each of these grades (giving equal weight to the four areas) and come up with a final grade for the company. I decided to use the typical college scale to assign a grade (4.0 = A, 3.0 = B, 2.0 = C, 1.0 = D, 0.0 = E).

Strengths:
Oracle has a lot of strengths going for it. It has a dominant brand, has the largest market share in relational database, has competitive products in two rapidly growing markets (application servers and B2B applications), a dedication to technology, and still has the same visionary leadership (Larry Ellison) that put these strengths in place. Because of all this, I am giving Oracle's strengths a grade of 3.7 (an A-). I can't give a grade of 4.0 because it is too early to tell if their B2B strategies are going to pay off (developing everything in house instead of partnering and focusing so much on web technology).

Weaknesses:
However, Oracle does have some significant weaknesses. It is slowly losing its dominance in the database market, the executive team is weak with no clear number two, there are some quality concerns regarding the application server and B2B applications, Ellison's style of management tends to put off partners and customers, and they have an over zealous employee stock option plan. While these weaknesses are definitely serious, they are not Enron or K-Mart serious, so I am giving Oracle's weaknesses a grade of 2.3 (a C+).

Maintaining Strengths and Overcoming Weaknesses:
Oracle is doing some things right to improve the above weaknesses and maintain the above strengths. They continue to spend a high percentage of their sales revenue on R&D, they keep a steady flow of advertising and press releases going to maintain brand recognition, they are starting to improve some of their quality concerns, and we are beginning to see a softer side of Larry Ellison. However, they do not seem to be doing anything regarding losing database market share (in most press releases they do not even acknowledge that they are losing market share), executives continue to receive outrageous ESO's, and their pricing model and business tactics are still alienating smaller customers and vendors. Its my opinion that Oracle is not doing nearly enough in this regard, so I am giving it a grade of 2.0 (a C).

Financials:
Oracle's financials are awesome. They have outstanding margins, generate consistent cash flow (even in this bad economy), a have ton of cash, no debt, and continue to generate high returns on equity. I am giving Oracle's financials a grade of 3.7 (an A-). I can't give a 4.0 because of the decreasing sales. It is too early to tell if this primarily because of the economy or the loss in database market share.

This gives Oracle a final grade of 2.93 (just under a B). Not a cream of the crop company, but no where near the bottom of the barrel either. With a few changes in company direction and the right recoveries in the economy Oracle could definitely be in the high 'B' low 'A' range in a few quarters.

Oracle's final grade does not definitely rule it out of consideration (below a 2.0 average or any one grade below 1.0 is my threshold for throwing a company out--I want above average companies not below average). After all, investing in a 'B' company at a great price might give better stock returns than investing in an 'A' company at only fair prices. So now we have to factor in value.

I am pretty comfortable saying that at recent prices (around 9.0), Oracle is not overvalued. The only indicators that the stock might be overvalued were the PEG ratio and comparing price to book with its competitors. However, comparing P/E ratios with Oracle's competitors and Grahams equation shows that Oracle might be undervalued. A discounted cash flow analysis shows that Oracle is undervalued with slightly aggressive growth rates and fairly valued with more conservative growth rates.

Taking this all into account, I've decided not to sell the Oracle shares that I already own (over the last three years I have bought three lots at an average price around 13.0). Here is my general reasoning: 1) I don't currently need the money, 2) I don't have a better place for the money, 3) the stock is not grossly overvalued, and 4) Oracle is still a solid company (final grade well above 2.0, no single grade below 1.0).

Now, I have to consider if I want to buy more. Most of my money is tucked away in mutual funds (some managed, most indexed). I am pretty comfortable that these funds will be able to return an average of 11% per year over the next 25 to 30 years. This is a doubling rate of approximately 6.5 years. So in order for a stock purchase to be worth the extra risk, I need it to double every four to five years (annual return between 14.5% and 18.0%). So basically, I have to answer the question: Is Oracle a good enough company, and trading at a good enough price, to double in four to five years? Or at recent prices, do I think Oracle can be in the 18.0 to 20.0 price range in four to five years?

If the economy picks up soon, Oracle will definitely resume growing. Currently, Oracle is not losing market share fast enough for it to stall in thriving economy. Or, if in the next few quarters, we see resurgence in Internet technology, Oracle will regain market share and resume growing. If both of these happen, Oracle will have no problems reaching the 18.0 to 20.0 price range in the next four to five years. However, we can't be guaranteed that either of these will happen.

The most aggressive discounted cash flow analysis shows Oracle fairly priced at 14.0. With this in mind, my instinct (which is usually wrong) tells me that Oracle will have no problem reaching 14.0 in four to five years. In order to get a double, Oracle would have to be trading at 7.0 sometime soon. To be honest, I don't think this is going to happen as there is already a lot of bad news build into Oracle's price and the rumor mill is that Oracle will not warn on its fourth quarter results.

So for now, I think I am going to split the difference and say that there is a very good chance that Oracle can hit 17.0 in the next four to five years. To get a double, I would need the stock to trade around 8.5. So if Oracle gets below 8.5, I will increase my position (assuming nothing else changes between now and then). Otherwise, I will look for another place to put my money.

--Craig


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