TCS Daily

Traditional Values Could Overlook Tech Bargains

By James K. Glassman - June 4, 2001 12:00 AM

Can you find value stocks in the tech industry? It may seem difficult. Even though the NASDAQ stands at less than half its value of March 2000, many tech stocks still trade at very high levels, according to traditional valuation models. But that doesn't mean that there aren't bargains to be found, even for the most traditional of investors.

When we talk about traditional valuation models, we're usually talking about one of two things - the earnings multiple or the book value. Using the first one, you value a company based on its price/earnings ratio, or P/E, which essentially means the number of dollars that investors are willing to pay for one dollar of a company's earnings. The P/E represents the price of one share of stock divided by the company's earnings per share. A high P/E ratio means that investors have a lot of confidence that earnings will grow in the future, while a low P/E suggests that investors are not very optimistic about the company.

Traditionally, a P/E in the mid-teens has been considered reasonable and attractive. But these days investors are very bullish (even after the 2000 tech wreck) on the future of digital technology in particular and on stocks in general - with good reason, I believe. As a result, stocks with P/Es in the 20s are now considered inexpensive, and tech stocks routinely trade at 40, 50 or even 100 times earnings.

The other traditional way to value a stock has been to look at its book value, or its net worth on the balance sheet. Book value tells you, if the company sold everything it owns and paid off all its debts, how much would be left over to pay shareholders. If the company's shares are trading in the market at or below the firm's book value, that means that the stock is cheap by traditional standards. In other words, investors have little faith in the talent of management and other intangibles. The market is saying that you might as well close down the company, sell off the pieces and mail whatever cash is left to the shareholders.

Tech firms usually trade at many times book value in part because there are no traditional menas to count the value of such assets as the human capital of engineers or the "network effects" of a widely used computer operating system. By contrast, a factory or a fleet of trucks will have a definite value. So at a given moment, an old steel company or a retailer with a pile of blue jeans on its shelves may appear to have much more valuable assets than an innovative software firm, if the techies haven't yet turned their brilliant ideas into cash. Of course, the techies may never figure out how to monetize their creativity, which is why book value still has relevance as you create a balanced portfolio.

Using traditional investment methods doesn't mean that you have to turn your back on tech stocks, but it does mean that the Ciscos and the Intels of the world may look expensive. Still, there are value stocks in technology. Take Oracle (ORCL), for example. The company's shares trade at a P/E of just 14. There's a reason for that, beyond the general slowdown in corporate spending. Oracle is now fighting a two-front war against Microsoft (MSFT) and Siebel Systems (SEBL), and it would be hard to find two better competitors in all of business. So a lot of people are expecting tough times ahead for Oracle. But given the company's history of fast earnings growth, Oracle stock is dirt cheap. And Oracle founder and Chairman Larry Ellison certainly doesn't lack for confidence or competitive zeal.

There are other potential bargains in technology. NCR (NCR), which makes automatic teller machines and other hardware and software, trades at just 16 times earnings. Autodesk (ADSK) is a leader in computer-aided-design (CAD) software, which helps manufacturers design everything from engines to airplanes. Autodesk trades at a P/E of 19.

And there's even a tech company trading at less than book value. 3Com (COMS) is the company that gave the world the Palm Pilot and Candlestick Park a new name. Palm (PALM) has been spun off into its own company, of course, and the San Francisco Giants abandoned "The 'Stick" for a new ballpark, but 3Com is still alive and kicking, focused on broadband modems and networking products for small companies. Investors have grave reservations about 3Com's future prospects, which may spell opportunity for stouthearted contrarians.

Buying value for value's sake alone is never a good idea. I am not interested in stocks just because they carry a low P/E or P/B. But these companies all have a good chance to grow swiftly, and that's what makes them potential bargains.

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