By
Chuck Carnevale
:
Within the world of investing exists a dichotomy that has often
befuddled and confused us. On the one hand, we have investors that
are interested in becoming owners of some of the most profitable
and rapidly growing businesses on the planet. And, on the other
hand, we have the trader mentality where the sole focus is on the
erratic nature of short-term stock price movement. But what is most
confusing of all is how even though the interests of these two
groups are the polar opposites of each other, the irony of all
ironies is that they need each other. The businesses need the
traders to provide the liquidity and capital they need to function.
The traders need the businesses in order to have something with
which to trade upon.
But the main point proposed from the above diatribe is how these
polar opposites functioning together can create anomalies that can
be exploited. We believe that one such anomaly that currently
exists is how the market is currently undervaluing the technology
sector. This sector contains some of our fastest growing and most
powerful companies with records of profitable growth that is
unequaled in the annals of business history. But even more
importantly, the odds are extremely high that the technology sector
sits at the forefront of the next leg of what might be the greatest
transformation in the history of business. Yet somehow, Mr. Market,
the short-term trader is currently seeing fit to price our best
technology companies at some of the lowest valuations ever.
If you examine most of our greatest technology names, you
discover that as a sector they are trading at below market
valuations. Yet, as a sector, they have produced the strongest
historical growth and are expected to produce some of the strongest
future growth as well. Today we find Microsoft (
MSFT
) trading at a PE ratio of 11, Oracle (
ORCL
) at a PE ratio of 12.9, and Hewlett-Packard (HPQ ) can be bought
at a PE of only 7. Even the mighty Apple (
AAPL
) computer only trades at a PE ratio of 15. These appear to be
extremely low valuations when you consider both the importance and
the promise of the technology sector's contribution to our
future.
The Possibility of Abundance:
Abundance - The Future Is Better Than You Think.
There is a new book soon to be published that we had the
privilege to be on the advance list of purchasers. With all the
pessimism and fear of the future so prevalent today, we highly
encourage every investor to get a copy of this important work. We
believe you will find that it is not Pollyanna but full of facts
and logical hypotheses supporting the case for optimism. The book
is titled Abundance - The Future Is Better Than You Think.
The book is written by Peter H. Diamandis and Steven Kotler, who
are both renowned visionaries.
"Dr. Peter H. Diamandis, is Singularity University Cofounder
and X PRIZE Foundation Chairman. The X PRIZE Foundation, leads
the world in designing and launching large incentive prizes to
drive radical breakthroughs for the benefit of humanity. Best
known for the $10 million Ansari X PRIZE for private spaceflight
and the $10 million Progressive Automotive X PRIZE for 100
mile-per-gallon equivalent cars, the Foundation is now launching
prizes in Exploration, Life Sciences, Energy, and Education.
Steven Kotler, is a science journalist. His articles have
appeared in over 60 publications, including: New York Times
Magazine, Wired, Discover, Popular Science, Outside, GQ, and
National Geographic. He writes "The Playing Field," a blog about
the science of sport and culture for PsychologyToday.com.E.
Steven Kotler is also the co-founder and director of research at
the Flow Genome Project, an international organization devoted to
putting flow state research on a hard science footing."
What follows are a few excerpts from part one of their book -
Perspective:
"technology is a resource- liberating mechanism. It can
make the once scarce the now abundant."
"Of course, the make more pies approach is nothing new, but
there are a few key differences this time around. These
differences will comprise the bulk of this book, but the short
version is that for the first time in history, our capabilities
have begun to catch up to our ambitions. Humanity is now
entering a period of radical transformation in which technology
has the potential to significantly raise the basic standards of
living for every man, woman, and child on the planet. Within a
generation, we will be able to provide goods and services, once
reserved for the wealthy few, to any and all who need them. Or
desire them. Abundance for all is actually within our
grasp."
"In this modern age of cynicism, many of us bridle in the
face of such proclamation, but elements of this transformation
are already underway. Over the past 20 years, wireless
technologies and the Internet have become ubiquitous,
affordable, and available to almost everyone. Africa has
skipped the technological generation, by-passing the land lines
that stripe our Western skies for the wireless way. Mobile
phone penetration is growing exponentially, from 2% in 2000, to
28% in 2009, to an expected 70% in 2013. Already folks with no
education and little to eat have gained access to cellular
connectivity unheard of just 30 years ago. Right now a Masai
warrior with a cell phone has better mobile phone capabilities
than the present United States did 25 years ago. And if he's on
a smart phone with access to Google, then he has better access
to information the president did just 15 years ago. By the end
of 2013, the vast majority of humanity will be caught in the
same World Wide Web of instantaneous, low-cost communications
and information. In other words, we are now living in a world
of information and communication abundance.
Oracle: A Paragon of Consistent Above-average
Growth
Oracle is a world leader in the database software industry, and
after acquiring Sun in 2010, is now the world leader in complete,
open, integrated hardware and software systems. According to their
website:
"With more than 380,000 customers-including 100 of the
Fortune 100-and with deployments across a wide variety of
industries in more than 145 countries around the globe, Oracle
offers an optimized and fully integrated stack of business
hardware and software systems that helps organizations overcome
complexity and unleash innovation."
The following graph plots Oracle's earnings-per-share growth
since 1998, which averaged 20.8% per annum. Notice that the company
initiated its first dividend in calendar year 2008 as depicted by
the light blue shaded area on the graph.
Although Oracle is a leader in software innovation with a strong
commitment to R&D, the company has primarily achieved its
growth through acquisitions. Since calendar year 2005, the company
has spent approximately $36 billion acquiring and integrating over
80 acquisitions.
click to enlarge
At Oracle's current price of approximately $28 per share, it is
a $140 billion market cap technology titan. We would estimate fair
value at approximately $49 per share (see earnings and price
correlating graph below), which would give Oracle a market cap of
over $246 billion. Consequently, we believe that Oracle, at its
current valuation, represents an opportunity to build a position at
a price that is almost 50% below its intrinsic value. The orange
line with white triangles represents a PEG ratio fair valuation of
20.8. Therefore, the reader should note that any time the stock
price is touching the orange line, it is trading at a PE ratio of
20.8.
But more importantly notice how the stock price has tracked the
orange earnings line over time. With the exception of the
irrationally exuberant period spanning 1999 to 2001, it is clear
that the market has generally capitalized Oracle shares in line
with its earnings growth. And, perhaps even more importantly, it is
clear that every time the stock price falls below the orange
earnings line, as it now does, it quickly comes back to value.
Consequently, we believe the below graph paints a clear picture
that based on historically normal valuation, Oracle is currently
undervalued.
When we calculate performance associated with the above graph,
we discover that Oracle has significantly outperformed the S&P
500 even considering the 50% undervalued case we made above.
Moreover, the 15.3% capital appreciation (closing annualized ROR)
correlates to earnings growth adjusted by low valuation.
With our next graph we overlay free cash flow (the orange shaded
area marked with an F) in addition to price and earnings. Here
we're provided a clear picture of Oracle's solid financial
condition which supports their ability to continue making future
acquisitions to support future growth.
On February 9, 2012 Oracle announced it is acquiring Taleo for
$1.9 billion or $46 a share. The Taleo acquisition follows their
recent acquisition of RightNow Technologies., a leading provider of
cloud-based customer service. RightNow's Customer Service Cloud
helps organizations deliver exceptional customer experiences across
call centers, the web and social networks. We believe that both of
these acquisitions indicate that Oracle is not willing to rest on
its laurels and past successes, and continues to assess the future
of technology.
Our next earnings and price correlated graph calculates Oracle's
earnings growth since 2003. This is offered to illustrate
remarkable consistency of Oracle's growth. Our first graph covered
the 15-year period (14-years plus the year were currently in) which
averaged earnings growth of 20.8%. When calculating the shorter
time frame since calendar year 2003, we discover that Oracle's
earnings growth of 20.2% is virtually identical to the longer time
period.
In order to continue with our analysis of Oracle's growth, we
shorten our time frame even further from 2008, the year of the
great recession, to current. Here we continue to discover the
remarkable consistency of Oracle's operating results. Once again we
find that since 2008 Oracle has continued to grow earnings in
excess of 20% per annum. Therefore, with each example we provided
continuing evidence that Oracle is currently undervalued. Each time
it has been undervalued in the past we see the stock price rather
quickly moves back to the orange earnings justified valuation
line.
Oracle's Future
A careful examination of the above historical graphs will reveal
that they do include forecasts for this fiscal year ending May 31,
2012 and a forecast for fiscal year ending May 31, 2013. Perhaps,
the forecast of only 10% growth in fiscal 2013 might partially
explain Oracle's current historically low valuation. Furthermore,
the consensus of 24 analysts reporting to Capital IQ forecast
Oracle's 5-year average earnings growth rate to be 13% per annum.
However, this is less than the 14.4% estimated growth by 19
analysts reporting to Zacks. Consequently, we are comfortable
estimating a range of future growth of 12% to 17%.
Additionally, the reader should consider that there is at least
a possibility of pessimism built into analysts' current thinking.
Although Oracle's last quarterly earnings report was solid, it
nevertheless disappointed analysts by missing by approximately 3
cents a share. However, if you study the annual rates of change of
earnings growth at the bottom of the above historical earnings and
price correlated graphs (orange shaded area), you'll see that this
is not the first time that Oracle had a soft quarter. The reaction
in their stock price acted like Oracle was going out of business,
and not that they still produced a very profitable quarter.
Thesis for Oracle's Continued Growth
There are several reasons why we believe that Oracle is capable
of continuing to grow its business at above-average rates far into
the foreseeable future. We believe that corporate spending on
software and services will continue to be in demand. Furthermore,
we believe that Oracle is poised to offer many innovative products
that are not currently factored into anybody's expectations.
Also, the company's financial condition remains excellent with a
solid cash position and the continuing ability to generate free
cash flow. Since we cannot know what acquisitions might be on the
horizon, we have to rely on their track record as a guide. And as
we have illustrated in this article, their track record is superb.
More importantly, so is the track record of their management team.
Management does not let any grass grow underneath them, and
continues to innovate. We for one don't feel it's wise to bet
against them.
The future for technology is certainly an unknown. However, one
thing that prospective investors should realize is that technology
does not grow in a linear fashion. Instead, both the history and we
believe the future of technology experiences exponential growth. No
other industry understands or participates in the power of
compounding more than technology has, and we believe will continue
to do. However, based on what we already know about technology, it
is clear that the developing world will be, and already is,
participating in the technology revolution.
For example, according to the book Abundance - The Future Is
Better Than You Think, referenced above, the
information/communication revolution that is now underway is
rapidly spreading across the planet:
"Over the next eight years, 3 billion new individuals will
be coming online, joining the global conversation, and
contributing to the global economy. Their ideas -ideas we've
never had access to-will result in new discoveries products and
inventions that will benefit us all."
Although it's hard to imagine what those ideas will mean, and
how much growth they will provide, we believe it's a safe bet that
Oracle Corp. will be an active participant.
Summary and Conclusions
We believe that Oracle Corp., as we mentioned in our opening
remarks, is just one of many technology titans that we believe the
market is mispricing. Furthermore, we believe part of that stems
from the general level of pessimism that has created the so-called
flight to safety out of equities. Pessimism thrives on uncertainty;
and one of the main attributes of technology is uncertainty. Any
time a long-term investor takes a position in a technology company
(business), they must do it with the realization that it's more
likely than not, that any future profits they are expecting will
come from products and/or services that don't even exist today.
Investing in technology is never without risk. However, the
above-average growth and above-average returns that technology
stocks have traditionally generated support the taking of the extra
risk. During more normal and benign market environments, technology
stocks usually command above-average price earnings ratios, which
add even more to the risk of investing in them. However, as we
previously indicated, many of our best technology stocks are
trading at historically low valuations today. Not only are today's
valuations lower than the norm for technology stocks, in many cases
they are below the valuations of the average company as measured by
the S&P 500. Therefore, we believe that investors seeking
maximum capital appreciation at reasonable levels of risk might do
well to take a hard look at not only Oracle, but the technology
sector in general.
Disclosure:
Long ORCL, HPQ, AAPL, MSFT at the time of writing.
Disclaimer:
The opinions in this document are for informational and
educational purposes only and should not be construed as a
recommendation to buy or sell the stocks mentioned or to solicit
transactions or clients. Past performance of the companies
discussed may not continue and the companies may not achieve the
earnings growth as predicted. The information in this document is
believed to be accurate, but under no circumstances should a
person act upon the information contained within. We do not
recommend that anyone act upon any investment information without
first consulting an investment advisor as to the suitability of
such investments for his specific situation.
See also
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on seekingalpha.com