Tech is the New Value: Cash Piles and Rising Dividends – Forget Buffett’s Fears

Warren Buffett’s aversion to tech stocks helped define value investing as portfolios full of the most arcane products on earth -- toothpaste, insurance and railroads, for example – but devoid of much post-1970s invention. In the past year, that fear of tech meant Buffett followers missed out on outsized gains in big, steady companies like Microsoft (MSFT) and Intel (INTC); companies that sure looked like value investments in every other sense of the word. With big tech shares again cheap and dividend payouts growing, perhaps it’s time to admit a truth Buffett probably never will: tech is the new value.

Apple (AAPL) crystallized tech’s shift toward the value category in March by declaring the world’s second-biggest dividend payout and plans to make the practice quarterly. Google (GOOG), too, may initiate a dividend soon, and that move would probably turn tech into the biggest dividend-paying sector on Wall Street. Really, though the list of computer and Internet companies turning into value plays has been growing for years now. A quick look at the tech sectors on YCharts shows price to book ratios near record lows for several cash-heavy earners, including Microsoft and Cisco (CSCO). They’re relatively low at Apple, Google and Intel too.

MSFT Price / Book Value Chart

MSFT Price / Book Value data by YCharts

Business models aside, a lot of mega cap techs now fulfill Buffett’s value criteria at least as well as Proctor & Gamble (PG). They have excellent balance sheets full of cash and little debt. They have kept shareholders happy for many years running with rising dividends and stock buybacks. Managements have long track records of earning money and spending it wisely even when the business climate isn’t great. Most of the time much better than archetypical value company P&G.

MSFT Return on Invested Capital Chart

MSFT Return on Invested Capital data by YCharts

In fact, chart-wise, several of today’s big tech companies today look an awful lot like Buffett’s beloved Coca-Cola Co. (KO). Even Apple, a company whose earnings and revenue gains make it a growth stock, is a Coke-level value candidate now. Apple’s estimated dividend yield at just under 2% compares to Coke’s 2.5%, and there’s no question whatsoever that Apple can afford it. Share price valuations based on book value are neck and neck, and have been for several years now. Even counting Coke’s dividends, who wouldn’t have rather owned Apple during that period?

KO Total Return Price Chart

KO Total Return Price data by YCharts

Buffett and his fans traditionally avoid tech investments because they prefer companies simple enough to describe to their grandchildren. They, like most investors, don’t really understand what the heck Cisco does to make money or how to value it. Unlike a rail company that collects a fee to carry coal from point A to B, Cisco makes the devices that send data, voice and video between computers. Patents and intellectual property of subjective value comprise much of Cisco’s book value, unlike the more tangible and quantifiable land and trains owned by a railroad.

But Cisco’s $100.6 billion market cap and 18-years of trading give us a reasonable sense of fair value for the company, at least on the historical basis that value investors treasure. And on the numbers now, Cisco plays out like a great candidate for a value investment. Its earnings and revenues have grown almost every year for the past decade. It offers a solidly-backed, growing dividend. Its share price is still down about 25% from mid-2010.

CSCO Chart

CSCO data by YCharts

Cisco, as it turns out, may be one of those dreaded value traps, a company doomed to low-value trading long-term because of operational issues it can’t conquer. The tech sector, of course, has value traps just like any other. Hewlett Packard (HPQ) seemed like great value last year after a couple of isolated scandals knocked down its shares, but those turned out to be just the beginning of its problems. Facing years of reorganizing, investors aren’t expected to see significant returns any time soon. Dell (DELL) shareholders may be in the same boat while the computer company tries to remain needed in a cell phone world. Then again, so are shareholders who practiced more traditional value investing with insurers Tower Group (TWGP) and Genworth Financial (GNW) or for-profit college DeVry (DV). Sometimes mighty companies turn cheap for good reason, regardless of the sector.

HPQ Chart

HPQ data by YCharts

But with the tech sector holding some of the best-run companies in the country now, even Buffett has warmed to it a little. He picked up a substantial holding in International Business Machines (IBM) last year and has even dabbled in Intel and DirectTV (DTV). But he’s made it clear he isn’t interest in the Googles or Apples of the market.

For more 21st century value investors, however, the sector is full of possibilities now. YCharts looked at the 10 largest companies in the iShares Dow Jones U.S. Technology Sector Index Fund and tested their credentials as value investments. We filtered out Hewlett Packard for its iffy future, and Oracle (ORCL) and EMC Corp. (EMC) for their stingy or absent dividends. (Google stayed in on the reasonable possibility of it paying a decent one.)

The remaining seven would all probably pass Buffett muster as outstanding companies, even if he isn’t interested in their shares. YCharts Pro gives each of them great marks for fundamentals and mixed reviews for share price value based on historic performance. Here’s a look at how they stand up as value investments now.

APPLE (AAPL)

Apple has avoided the uncool title of value stock by continually creating earnings and revenue gains bigger than a lot of so-called growth stocks. The old man – and yes, Apple is a 32-year old public company with a $529.8 billion market cap – reported 63% profit gains in the past 12 months alone, along with 42% sales gains. And it’s not like it was just rising over some nasty results a year ago. Apple growth has been fast-paced since the general economic recovery started.

AAPL Revenues TTM Chart

AAPL Revenues TTM data by YCharts

Normally, such fast revenue growth would ramp up valuations on a company’s shares. But Apple’s ability to turn sales into even higher profits means its price/earnings ratio has gone down to a mere 13 or so. Its price to book value, however, is over 5 again, which makes it one of the most expensive mega-caps in the S&P 500. (Coke is slightly higher.)

Apple also has a dividend on the way and more cash flow than necessary to cover it. The ubiquity of iPads and iPhones and iPods, all sold for years at great profits, stands as testament to management savvy. So does the 430% gain in its share price in the past five years.

AAPL Chart

AAPL data by YCharts

In other words, while Apple excels in the categories value investors cherish, its shares are not exactly the underappreciated assets value investors seek. But with profit growth continually outpacing revenue growth, it’s not as far off as one would think.

MICROSOFT (MSFT)

In contrast to Apple, Microsoft shares represent some of the cheapest of the mega-sized techs, with a share price of barely 11 times earnings. Its price-to-book value hasn’t been this low in a decade.

MSFT PE Ratio Chart

MSFT PE Ratio data by YCharts

Microsoft has had mixed success in its efforts to expand its software sales from the slowing personal computer market to faster-growing platforms like cell phones and tablets, and that’s contributed to the ho hum performance of its shares in recent years. But PC sales unexpectedly improved this year, just as Microsoft prepared for its biggest product launches in years: the Windows 8 operating system and a new version of Office. The news breathed new life into Microsoft shares, which could have been purchased at a Pe ratio below 10 just a few months ago.

MSFT Chart

MSFT data by YCharts

Regardless, Microsoft still looks like a quintessential value play. Revenues have risen steadily on big successes in small products, like Xbox game consoles. Profit gains have been further behind, as spending on the new products increased. But the company rewarded shareholders for their patience with a 25% dividend increase late last year. The yield now sits at about 2.6%.

INTEL (INTC)

Computer and phone-chip maker Intel has raised its dividend three times in 18 months, which ironically has sparked more worry than glee in some investment circles. Does this mean Intel’s famous 20%-plus annual growth is coming to an end?

Company CEO Paul Otellini insists not. As the dominant PC chip maker around the world, past growth has come by taking market share in the computer industry. Future gains should come from sales of Intel’s new, low-power microprocessors for smartphones. That will mean taking some business from competitor Qualcomm (QCOM), a company that has so far beat the pants off Intel in the fight for smartphones. The stakes are high – growth for all chipmakers is in mobile devices, not so much PCs – and the competition in the past couple of years has done little for Intel’s profit margins.

INTC Gross Profit Margin Chart

INTC Gross Profit Margin data by YCharts

Meanwhile, Intel’s dividend yield of 3% is the best of the pack, and its shares retain some of the lowest valuations.

INTC PE Ratio Chart

INTC PE Ratio data by YCharts

GOOGLE (GOOG)

Google’s main deficit as a value investment is its lack of a dividend, a problem a lot of pundits expect to be soon rectified. The company simply has so much cash that hoarding it is beginning to look downright stingy, especially in light of Apple’s recent decision to share.

GOOG Free Cash Flow TTM Chart

GOOG Free Cash Flow TTM data by YCharts

Otherwise, the shares’ 10% droop this year against broad market gains puts it nearer value territory. Its price-to-book and price-to-earnings ratios are at all-time lows. Even the tech sector exchange traded fund Google dominates has done much better.

GOOG Chart

GOOG data by YCharts

Investing experts of all stripes remain very optimistic about the company’s long-term future, and the vast majority of its professional followers recommend buying the shares at these levels. Keep in mind that the dividend rumors may be just that, which would be a bummer for anyone buying it for value.

INTERNATIONAL BUSINESS MACHINES (IBM)

It was IBM that lured Buffett into the tech sector, but not, apparently, for its technological genius. No, Buffett was impressed with IBM’s management team and their shareholder-friendly ways. And the fact that it’s more of a service company than a tech innovator these days.

IBM has evolved from America’s foremost inventor to the world’s biggest IT department. After inventing the ATM, the hard drive, microprocessors for game consoles, and all manner of software, IBM now gets a significant portion of its income from corporate clients who need help managing and integrating all their techno-stuff. The transformation has done wonders for IBM’s bottom line, even though revenue growth hasn’t been particularly strong.

IBM Revenues TTM Chart

IBM Revenues TTM data by YCharts

The dividend grows in annual stair steps, but its yield remains a paltry 1.75%. Share repurchases are common. Share price valuations, which include one a price-to-book value more than double Apple’s, hardly seem in value territory. Then again, they weren’t a whole lot less expensive when Buffett was buying them.

IBM PE Ratio Chart

IBM PE Ratio data by YCharts

QUALCOMM (QCOM)

Qualcomm makes or licenses the microprocessors for every 3G and 4G smartphone ever sold, so it’s not terribly surprising that its revenues and profits are up more than 60% in two years. The competition is building, but Qualcomm’s biggest problem so far has been keeping up with demand.

QCOM Revenues TTM Chart

QCOM Revenues TTM data by YCharts

Qualcomm’s share price resembles Apple’s in the sense that really great earnings have kept its valuations from getting ridiculously out of hand. Its ratios remain lower than they were in 2010 or pre-recession and are mid-range for the chip makers.

QCOM PE Ratio Chart

QCOM PE Ratio data by YCharts

That’s one reason that the buy recommendations on its shares outstrip any other kind of rating by almost three to one. But is it a value investment?

Not really. Even with a recent hike, the dividend yields well under 2%. There’s been no recent development that leads investors to question the value of its shares, which are in fact up nearly 70% in the past two years. While the share price isn’t astronomical, it’s at a level that might make them particularly vulnerable to bad news, like if Intel manages to eat into its markets. That’s a worry best left for growth investors.

CISCO (CSCO)

None of the stocks on our list scream “potential value trap” quite as loudly as Cisco. But its value play credentials, including an excellent balance sheet, are so strong that it shouldn’t be dismissed outright. And some expert tech analysts believe the company is on the brink of a turnaround.

Cisco rose to force by inventing ways that computers talk to each other, including some of the best early wireless routers. Its products and services traditionally commanded premium prices. By 2011, however, all sorts of companies were doing the same thing, and doing it cheaper. Cisco also made the mistake of investing heavily in a variety of hardware like GPS and computer-ready video cameras that were replaced by $1.99 phone apps. Cisco’s profit margins plummeted.

CSCO Gross Profit Margin Chart

CSCO Gross Profit Margin data by YCharts

Cisco spent last year extricating itself from businesses that don’t focus on network computing, figuring that the corporate world still has an increasing need to make computers and phones and other technology interact. About half the analysts who follow Cisco recommend buying it, largely on the belief that its margins can’t fall any further and the shares are oversold. The other half tends to worry that Cisco faces a long slog back to the days when corporations were willing to pay up for superior quality.

Meanwhile, its dividend, now yielding about 2%, looks particularly safe. Cash alone could more than cover it. Even with recent troubles, the dividend remains a miniscule percentage of its cash pile.

CSCO Cash Div. Payout Ratio TTM Chart

CSCO Cash Div. Payout Ratio TTM data by YCharts

Dee Gill is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.

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