What it does
Oracle sells database software (which helps organize and query data), application software (which supports business processes), and middleware (which connects different types of software, including application and database programs) to businesses. Its flagship product is Oracle Database, which is the clear market leader with a 50% share. IBM
Oracle's revenues have grown by approximately 13% annually over the past 10 years and 20% per year over the past five years. Because enterprise software drives productivity gains, its market is growing, and industry analysts and Gartner say the trend will continue.
"We have identified a strong correlation between GDP growth and enterprise-software spending growth, where software tends to grow 4% to 6% above GDP in normal market conditions," says Joanne Correia, Gartner managing vice president.
Global GDP has grown by about 3% to 4% since 1970, and if that rate continues, it implies that the enterprise-software market will expand by 7% to 10% annually.
Warren Buffett has a quick-and-dirty quantitative test for competitive advantage: He looks for high returns on equity without debt. Oracle, which has more cash than debt, has never posted less than a 22% ROE for the past 10 years, and its five-year average is 25%. For perspective, the average ROE on the market is about 11%, based on the 5,891 companies that NYU finance professor Aswath Damodaran tracks. In other words, Oracle is more than twice as profitable as the average company.
Oracle has a strong management team. Larry Ellison, who founded the company in 1977, is still the CEO. He's a tech-business visionary who has transformed a startup business into the world's second-largest software company, after Microsoft. In addition, President Mark Hurd has a successful track record at both Hewlett-Packard and NCR.
The executive compensation at Oracle, however, is high. The top eight officers pulled down $283 million in 2011, with Ellison and Hurd each earning in excess of $75 million. On the other hand, the company has generated better than 13% annual returns over the past 15 years, which is significantly greater than the 6% annual returns the S&P 500 has generated. So maybe this gold-plated management team is worth the cost.
Oracle has a strong balance sheet -- 10% of the market cap is in net cash, and it also produces a steady stream of cash. In the past year, the company produced almost $13 billion in free cash flow, which equates to a 9% yield to enterprise value. Yet despite its history of growth, high margins, and entrenched position, it trades at the same price as the S&P 500, based on its trailing P/E of 16. With a forward P/E of 12, it's cheaper than the S&P (13), IBM (13), and SAP (20).
Foolish bottom line
If margins hold steady and revenue growths at a 5% to 10% annual rate, Oracle's stock could easily double in the next five years. You could probably find a cheaper stock, like Dell, or a higher-quality business, like Coca-Cola, but I doubt you'll find a better bang for your buck than Oracle.
Brendan Mathews owns shares of HP. The Motley Fool owns shares of Coca-Cola, Microsoft, and Oracle. Motley Fool newsletter services have recommended buying shares of Coca-Cola and Microsoft, writing covered calls on Dell, and creating a bull call spread position in Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.