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.
