It's not often an investor comes across a technology company that continues to grow and invest in innovation while meeting commonly accepted criteria that universally apply to "value stocks." And for good reason: What are traditionally known as value stocks are companies trading at low ratios to their earnings, tangible book value, and so on.
Ben Graham, Warren Buffett's mentor, created the value-investing methodology, while Buffett and scores of his peers are fine-tuning it to this day.
Technology companies, for better or worse, trade based not on historic cash flows and assets, but on the hope of future profits from major, and hopefully in-demand, technological advances. Measuring such leaps is, inevitably, more or less impossible. Imagine trying to calculate the future market value for Microsoft's products when it went public in 1986. In hindsight, we know that Microsoft went on to monopolize the desktop PC software market, but no one knew that would happen in 1985.
However, once in a while, a tech company with strong chances of future growth happen to trade at what many a value investor might call "undervalued." These names are elusive but not impossible to find. With that in mind, some of The Motley Fool's best and brightest put their heads together to identify three names to get you on your way to finding the most undervalued tech stocks on the market today.
Read on to learn why the companies they identified -- IBM (NYSE:IBM), Skyworks Solutions (NASDAQ:SWKS), and Cisco Systems (NASDAQ:CSCO), are the most undervalued technology stocks in the market today.
Tim Brugger (IBM): At just over 10 times future earnings, IBM is trading on the cheap, particularly relative to its peers. Why? The answer explains why IBM warrants a spot on this list of undervalued tech stocks.
IBM was caught napping as its legacy hardware and enterprise businesses became an afterthought in a mobile, connected, cloud-based world. Though it's late to the game, IBM CEO Ginni Rometty has Big Blue leading the charge into cognitive computing, data security, and the Internet of Things, all delivered on the cloud.
As a key component of Rometty's "strategic imperatives," IBM continues to score deals involving its machine-learning wonder, Watson, including its recent agreement with UK-based Alder Hey Children's Hospital. Analytics, mobile, and security round out IBM's strategic imperatives, along with cloud sales, all of which grew again last quarter.
Analytics revenue, where Watson-related sales reside, climbed 7% in Q1, while mobile was up 88%, and security sales jumped 18%. But IBM's combined 14% improvement from its strategic-imperatives group was led, again, by its impressive $10.8 billion annual cloud revenue run-rate. Combined, IBM's critical new-ish imperatives now make up 37% of total sales, well on their way to hitting Rometty's goal of 40% by 2018.
The "problem" continues to be investors' and pundits' reluctance to let go of IBM's legacy businesses and concentrate on what's driving its future, which is why it's undervalued. Transforming a tech-industry mainstay isn't a quick or easy proposition, but for patient value investors who could use a 3.75% dividend yield until its transformation is firmly established, IBM warrants a good, long look.
Brian Feroldi (Skyworks Solutions): Smartphone suppliers have been beaten down in the wake of Apple's first-ever year-over-year decline in iPhone sales, which could spell opportunity for investors who take a longer-term outlook. That's why I think Skyworks Solutions (NASDAQ:SWKS) could be an interesting stock to buy today: It's cheap, it's growing, and it even comes with a respectable 1.7% dividend yield.
Skyworks is a semiconductor manufacturer that supplies chips to nearly every major smartphone maker in the world. The company's revenue growth over the past five years has been outstanding, compounding at a rate just over 20%. That growth has come largely on the back of the huge growth in the smartphone market, but there are plenty of reasons to believe that Skyworks' growth story is still in the early innings.
Skyworks is pushing hard into new markets that are poised to benefit from increasing connectivity. With each passing quarter the company announces design wins in new markets such as smart TVs, drones, automobiles, and security cameras. That makes Skyworks a major player in the Internet of Things trend, which many predict will experience explosive growth over the next decade.
That's all great, but what really impresses me about Skyworks is that it's managed to grow its sales without sacrificing profitability. Last quarter the company recorded a non-GAAP gross margin of 50.8%, up 410 basis points year over year. That's an amazing accomplishment for a chip manufacturer, let alone one that counts almighty Apple as its biggest customer. And it speaks volumes about how strong its competitive position is in the industry.
Skyworks' management team is forecasting that the upcoming quarter will be a rough one, as revenue and earnings are projected to decline. That's caused traders to flee over fears that the company's growth story is over, which now has shares trading for around 12 times trailing earnings. With the company entering so many new markets, I don't think its days of growth are over -- which makes right now a good time to buy into a company with a pristine balance sheet, a history of success, and a bright future ahead.
Sean O'Reilly (Cisco Systems): My pick just about has it all. Cisco is a major provider of Internet networking products, helping businesses and individuals move voice, video, and other forms of data across a plethora of network types.
Over the past 12 months, Cisco has generated over $12.5 billion in free cash flow, a number that should make your eyeballs pop, especially because the company has generated over $10 billion in free cash flow annually for the past four years. It's used this cash to buy back shares (over $29 billion worth since fiscal 2011), pay dividends ($4.09 billion in fiscal 2015 alone), and invest in the Internet of Things (IoT) as well as various other mobile internet initiatives.
The company is partnering with Ericsson and Intel to develop a 5G mobile router for both business and residential networks. The importance of this initiative cannot be overstated, as it gives Cisco and its partners a foothold in the burgeoning Internet of Things, by offering its customers 1GB-per-second download speeds. The Internet of Things is something Cisco is taking very seriously. It recently spent $1.7 billion buying a company named Jasper, and $260 million on another named CliQr -- two organizations that help customers manage and monetize IoT systems and services.
If owning a company with a solid head start in gaining a foothold in our Internet of Things-fueled future doesn't get you excited, then maybe Cisco's valuation will.
Cisco sports a market capitalization of $140 billion and is expected to generate net income this year of around $10.3 billion, or $2.05 per share. It's trading at 13.65 times forward earnings, and it's expected to grow its earnings to a respectable $2.31 per share by fiscal 2019, according to analysts polled by S&P Capital IQ. Given those numbers, you might think Cisco is trading for a reasonable but not cheap valuation -- until you glance at the balance sheet.
Cisco has been extremely profitable for years and has racked up an extremely healthy bank-account balance -- to the tune of $64.5 billion in cash and cash equivalents. Now, all of a sudden, Cisco's valuation becomes all the more interesting. After subtracting $24 billion in total current liabilities, netting us a cool $40 billion in free cash, Cisco has an ongoing business that's trading for an even $100 billion.
So is anyone else interested in buying a strong technology franchise, one with a solid foothold in the burgeoning Internet of Things industry, at just 10 times earnings?
I thought so.
Brian Feroldi has the following options: long January 2017 $195 calls on International Business Machines, short January 2017 $195 puts on International Business Machines, short January 2017 $190 puts on International Business Machines, long January 2018 $175 calls on International Business Machines, and short January 2018 $175 puts on International Business Machines. Sean O'Reilly has no position in any stocks mentioned. Tim Brugger has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Skyworks Solutions. The Motley Fool owns shares of Microsoft and has the following options: short June 2016 $70 calls on Skyworks Solutions. The Motley Fool recommends Cisco Systems and Intel. 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.