Tuesday, November 12, 2013

Is Old Tech Right for Dividend Investors

To me, technology stocks tend to be the ultimate for fad, momentum and market timer investors of all types, and not the usual shopping ground for value or dividend investors. However, old technology may be an exception to the rule. These companies have moved from their glamor growth days of adolescence to become solid middle-aged citizens making slow and steady progress. As a result, their PEs have shrunk back into value territory and their hoards of cash are now being deployed on dividends and share buybacks, something that would never even have been contemplated by these companies 10 or 15 years ago. The amount of foolish and expensive acquisitions has also slowed down now that they can no longer use an inflated stock price to pay eye-popping numbers for companies with little to no sales. Growth has slowed as well, and deflated PEs, but these companies still generate massive amounts of free cash flow.
Before I launch into my discussion and in the spirit of full disclosure, I work in the IT field and have numerous personal experiences with these companies. I’ll try not to let these experiences influence my opinions unduly, but it is hard not to form an opinion about a given company’s employees.

Microsoft is the tech company everyone loves to hate. It seems that Microsoft can do nothing right if you read the trade rags. I have a very different opinion. Microsoft has clearly been very slow in anticipating technology trends, and has been playing catch-up to its more nimble peers. You can’t argue that, whether it is search, online email, game consoles, operating systems….. they have been slow on the draw. They have also grossly overpaid for acquisitions and been forced to write down some of these investments. But unlike much of the tech press, I’d argue that Steve Balmer has actually positioned the company pretty well for the future. Windows 8.1 is actually a good operating system that is configurable enough to hide some of its most annoying features. The Surface 2 is a wonderful small form multi-purpose PC that corrects many of the short-comings of the 1st generation Surface. Office is under threat from Google Docs and LibreOffice for basic functionality, but continues to be a cash cow for the company. The Windows phone is a low cost alternative to the iPhone that, in my opinion, provides a better user interface than Android and will continue to chip away market share. Azure hosting services and SharePoint are both doing extremely well, while Bing and Xbox are lagging. Their pending acquisition of Nokia continues their metamorphosis into an Apple-like company that produces both hardware and software. I’ll add one last comment that their sales people are very easy to work with and knowledgeable about the company’s products. At $37 Microsoft is a little rich for my blood, and would prefer to pick it up under $34. I view Microsoft as a steady-eddy kind of stock in the tech sector.

Hewlett-Packard is a company that is in deep trouble and deservedly sells at a bargain price. They are on the wrong end of just about every technology trend and in their desperation have made foolish acquisition after foolish acquisition looking for a quick fix to their problems. Printers are the crown jewel or their operation, and selling printer ink refills is a very profitable business, but even their printer business is declining. In their recent quarterly report, the only sector in their business portfolio that didn’t decline was software with a 1% increase in revenue. Whether Meg Whitman can turn this company around remains to be seen, but she has at least but a stop to their streak of ridiculously overpriced acquisitions and directed access cash to stock buybacks instead. I don’t view HP as a long-term hold kind of stock, because I think their decline is almost inevitable, but they could make an interesting turnaround play for short-term money. Their sales force in my experience was inept and uninformed about their own products, and their service was spotty at best. There is not enough of a margin of safety for me to buy this low-quality stock at these prices, and I certain would not consider HP to be type of stock a dividend investor would want to hold for decades. It was a turnaround play when it hit the mid to low teens. HP isn't going out of business tomorrow, but I would think of buying unless it drifts back into the low twenties, and only then as a short-term speculation.

Oracle provides database products and services as well as a number of customizable packaged business solutions built on top of their database engine. They also sell Unix/Linux hardware through their Sun subsidiary. As a customer, the oracle database engine is a first rate offering, but Oracle as a company is truly a pain-in-the-ass to work with. Most other customers I’ve talked feel the same way, and regret their decisions to buy Oracle’s packaged business solutions. The typical customer spends a small fortune getting their business solution implemented (much more than their ever would have guessed), but are unable to switch to a different product because the costs to switch are almost as high as the costs to implement. Oracle attempts to nickel and dime their customers at every turn. I refuse to do business with them and won’t buy their stock.

Apple is still a tech darling though their stock price has come back down to earth. Apple is known for producing high-quality, but expensive products from the iPod to the iPad to the iPhone and PCs. I won’t buy their products because I can find cheaper alternatives that satisfy my needs, but that doesn’t mean I don’t admire the company. The concerns with Apple are the dependency on a few key products that if they fall out of fashion or get leapfrogged by another company could have a devastating impact. The other problem is what to do with the hoard of cash that is not benefiting the shareholders in any way sitting in the bank (oh, to have those kind of problems). Carl Icahn is trying to force Apple’s management to use this cash in a shareholder friendly way. Apple is a tech company to buy at the right price, but investors need to keep a close eye on the company. Things could turn bad for them very quickly if they are out-innovated by another company.

Cisco still owns the network. They also now own IP-phones and are entering the blade server market. Gone are the days where they paid billions of dollars for companies with no sales. Like the IBM of old, no one ever gets fired for buying Cisco. Cisco has a reputation for nickel and diming their customers, but to a lesser degree than Oracle. Cisco has become much more shareholder friendly and is a buy with a yield above 3%.

Intel was the dominant chip maker of the PC-era. They missed the boat on mobile and notepads, and are now trying to catch up and gain market share in those growing markets. Investing in Intel is a bet that their scientists can close the gap with competitors like Qualcomm. In the meantime, they have the free cash flow to support the necessary R&D investment and capital spending require to refocus their operations to devices other than the PC.

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A word of caution on investing with technology companies. It is rare that any of them can stand the test of time and the rapid pace of technology change. Investors need to closely monitor these companies and technology trends and be ready to pull the plug when it is obvious that a company has lost its technological edge, least they get stuck slowly dying company like Blackberry.

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