A Value Investor's Guide to Technology

 | Mar 24, 2014 | 12:30 PM EDT
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For better or worse, most self-ascribed value investors invest with an aversion to technology stocks. In many ways, tech stocks don't pass some of the "fundamental" tenants of value investing. Price-to-earnings ratios are usually, or even more so, non-existent. Because most technology stocks are out to innovate and, thus, achieve above normal rates of growth, they are valued accordingly, making them very difficult for value investors to handicap.

That being said, technology is the business of the future. More and more humans are becoming connected to the Internet via mobile devices, computers and social networks. Several years ago, Warren Buffett was asked at a shareholder meeting about his circle of competence. Specifically, the question was: "If you could increase his circle of competence to another industry what would it be?" Without delay, he remarked technology. That answer probably explains why a couple of years later, Buffett purchased $10 billion worth of shares into IBM (IBM).

Fret not, value investor, you can buy into technology today and do so intelligently. As is the case with stock prices in general, they are a lot higher today than past years. For tech stocks, the prices have gotten a lot higher. But building a basket of tech stocks today can be an intelligent approach to benefiting from the future connectivity of the world. I would definitely consider IBM a key choice. For one, you hope that Buffett hasn't lost his touch. Second, the share price has lagged the overall market -- the stock trades at 13x earnings.

Cisco (CSCO) is clearly another high quality name to put in the mix. The stock price hasn't moved much in years. Management has announced plans to move heavily into cloud computing, aiming to develop the world's largest global internal cloud to go toe-to-toe with Amazon. You earn a tidy 3.5% yield to own a company that earns over $10 billion a year in free cash flow against an enterprise value of $85 billion.

Another name to go into your tech basket is Apple (AAPL) -- thanks to Mr. Market no longer seeing Apple as a "growth" stock. With tons of a cash flow and a solid future as one of the top three mobile device makers in the world, Apple's current price definitely makes it very digestible for the value investing community.

Add Microsoft (MSFT) to the basket as well although the 45% advance in the stock price over the past year certainly takes a little of the sizzle of the opportunity. But a new CEO offers a fresh perspective for the tech stalwart and the introduction of MS Office on the iPad could be a game changer.

Unfortunately, the names everyone wants to love -- Facebook (FB), Netflix (NFLX), and Amazon (AMZN) -- are just a little too optimistic for my blood. But right now, optimism rules the day and that could be a dangerous thing for those who are adventurous. However, the other names mentioned above are all likely going to play a key role in the migration to mobility and the cloud for years to come.

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