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. While 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 (ORCL) 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 (ORCL) 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.
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