Back to Microsoft and Apple

 | Sep 09, 2013 | 4:30 PM EDT  | Comments
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Technology stocks are often treated like babies being thrown out with the bath water. That's because investors have little regard for technology stocks once the sizzling growth rates are over.

It's almost as if investors deem technology stocks worthless with respect to future value after the hot phase cools down. Readers know I'm a fan of Warren Buffett and that Buffett has an aversion to technology stocks, citing lack of future visibility in the rapidly-changing technology industry. No one will deny Buffett's assertion. But even he can't deny the power of technology today and he has more than acknowledged that with a $10 billion-plus investment in IBM (IBM).

Neither can anyone refute the staying power of two stalwarts, Microsoft (MSFT) and Apple (AAPL). These are two of bluest of blue chips in the technology world, perhaps Microsoft more so than Apple. Yet both have demonstrated the ability to generate gobs of free cash flow year after year. And free cash flow is the undeniable value creating metric: The intrinsic worth of any business is the present sum of all the future cash that can be taken out of that business.  

Where Microsoft has fallen "short" for investors is that it can no longer reinvest the $25 billion or more in free cash flow it generates each year at the 30% to 40% it was doing a decade ago. Despite a return on investment of 30% even today, Microsoft can only generate that return with a small slliver of cash, with the balance piling up.

Most analysts will tell you that Microsoft overpaid to buy Skype and is doing so again with its plan to shell out $7 billion for Nokia's smartphone business. But the market doesn't punish Microsoft because it can afford to. That being said, an activist investor has taken interest in the company and a new CEO will be anointed next year. Expect to see more emphasis on stock buybacks and additional dividends. Last week's 7% drop in the share price on the Nokia news opens up a nice opportunity. 

The same basic premise goes for Apple, even though its growth profile still remains attractive. But Carl Icahn isn't going to waste any time working to get Apple to use its mountain of cash to aggressively purchase more shares. It appears that CEO Tim Cook understands this and won't waste much time utilizing the cash prudently. 

Summing up, MSFT and APPL trade for approximately 12x earnings, a significant discount to the overall market and even greater discount to their peers. Given their pristine balance sheets, I would say that both companies offer investors a safe and stable place if you are looking to reallocate some capital for a multi-year holding period.

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