Like many other formerly high-flying stocks, Oracle (NASDAQ:ORCL) continues to post solid growth, but it's been watching its price stagnate following the bursting of the tech bubble. Investors have increasingly begun to monitor this baffling trend at companies such as Microsoft (NASDAQ:MSFT), Cisco (NASDAQ:CSCO), Wal-Mart (NYSE:WMT), and Home Depot (NYSE:HD). Businesses that traded at more than 50 times EPS have seen earnings continue to grow at a healthy pace, but their stocks have been virtually unchanged over the past 60 months.
In Oracle's recently announced third-quarter earnings, results were strong, but a bit difficult to discern because of the just-closed Siebel acquisition. It is apparent, however, that the company throws off prodigious amounts of free cash flow.
Oracle has caught the interest of other Fools as well, including Tim Beyers and W.D. Crotty, who dueled on the subject back in January. Indeed, the company is almost a case in point for Rule Maker investing, with a leading brand (enterprise software), mass-market appeal (check out the list of Fortune 500 clients), strong historical performance (the company, not the stock!), profitable and growing business, and robust and growing levels of free cash flow. Oracle appears to have it all. So why is the stock down over the past five years?
Oracle and its fellow struggling stocks appear to be stuck in a no-man's-land between the value and growth investing crowds. Earnings are strong, but not accelerating, which keeps the growth crowd from piling into the shares. On the flip side, the companies haven't experienced enough serious difficulties to pique the interest of the turnaround or value guys. For a growth-at-a-reasonable-price (GARP) investor like myself, this is akin to the Goldilocks economy of the 1990s -- the stocks are neither too hot nor too cold, but just right.
I've always felt that it is extremely important to estimate the implied growth built into a stock price when deciding whether or not to make an investment. Back during the tech bubble, the implied growth in most technology stocks was stratospheric, meaning that investors were making wildly optimistic growth assumptions. These estimates were so high, in fact, that it has taken nearly five years for earnings to catch up and valuations to return to more reasonable levels. For Oracle, based on this fiscal year's consensus EPS of $0.78 (ending in May), I estimate that the company needs to grow about 9% over the next ten years to justify its recent stock price ($13.80). Major inputs include a 12% cost of capital and 3% terminal growth rate. Condensing the time period a bit, the company would need to grow earnings at about 14% annually over a five-year period to justify the current stock price. As always, a sensitivity analysis is helpful for determining a reasonable range of values.
Many things can happen over the next five to ten years, but based on Oracle's market dominance and its continued consolidation of the industry through acquisitions, it's likely that the company could exceed implied growth projections. That, my Foolish friends, could mean that the shares are currently undervalued. Right now the market is digesting a number of Oracle's large acquisitions and awaiting further visibility on the organic growth potential of the newly formed entity. If all goes well and no further deals are made, the stock price could rally along with earnings.
For related Foolishness:
Microsoft and Home Depot are Motley Fool Inside Value selections.
Fool contributor Ryan Fuhrmann is long shares of Cisco and Home Depot, but he doesn't currently hold shares of Oracle. Feel free to email him to further discuss any of the companies mentioned above.
