The Good and Stupid of Tech

Oct 27, 2011 | 12:27 PM EDT
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The autumn tech rally is in full swing, despite funky earnings reports from many companies.

One of the standouts of the tech sector in Q3 was Intel (INTC). Tremendous revenue growth, copious free cash flow, record profit and margins all compare favorably to most other semi companies. Go ahead, find a large-cap semi with better fundamentals. I challenge you. The Intel perma-bears have some serious rethinking to do, especially those high-visibility, always-negative Street analysts. Intel remains very undervalued if they keep rolling on, as all fundamentals indicate.

Last year I wrote Intel was the perfect stock with double-digit revenue growth, high profitability, fat dividend yield and a serious competitive advantage. I reiterate that today. At 10x profits and with a 3.4% yield this category killer is just too cheap.

Seagate (STX) has been a good stock for me, mostly because I kept adding at the low end of the range. The HDD industry has been much maligned in the financial press, as naysayers continue to overstate the imminent threat of tablets and solid state drives (SSDs). To the contrary, last quarter HDD demand was at record levels. Strong growth in mobile content is pulling through huge HDD demand for big storage in the data center environment.  Intel and Seagate are serving this demand very profitably. With the Thai floods removing a huge chunk of capacity for a long time, there is a serious shortage of HDDs, and prices are up 20-50% across the board.

Seagate, along with Samsung, should mint money in 2012 if they execute well.  I can imagine a $5 billion June with $1.50 per share profit in one quarter. At 5x my 2012 estimate, with a 4% yield, the trade should still have legs.

Hewlett Packard (HPQ) is the runt of the litter. The worst board of directors on the planet keeps screwing up with strategies that destroy shareholder value. Somehow HP directors think making small company acquisitions, at huge valuations, which don't move the needle in the HP business mix is smart. They are fools. Some activist shareholder should launch a proxy fight to replace the entire HP Board for gross financial negligence.

One simple decision to allocate 40% of HP's annual free cash flow to the owners of the company in the form of dividends would solve many problems with their capital allocation mismanagement. That would generate a $1.50-$2 dividend, and since no tech stocks yield 5%, the stock would soar. Anyone want to forward this to Carl Icahn? At 5.5x my 2012 estimate, the stock is stupidly cheap, but it comes with a stupid Board and their stupid capital allocation plan. Change here would be good and profitable.

A new tech in my long book is Molex (MOLXA). This leading global connector maker is a consistently profitable performer with exposure to growth in all types of electronics, from computers to medical devices, and from tablets to machine tools. The company has large exposure to smart phones and tablets as these devices consume multiple connector value vs. simple cell phones. This positive mix shift is generating high margin growth. At 12x profit and with a 3.5% yield, this high quality company with a fortress balance sheet should thrive.

The bull case for equities is playing out. The economy is tenuous, but holding together and Euro Can Plan is kicking full force. And many investors got caught with their risk-on pants down. Looking to catch upside might still be a decent option. Stocks have had a good run, so one needs to be careful. But if one can find the stock laggard and get a decent quarter, the high end of the range would represent a profitable long rental.

I continue to very selectively add to cheap longs with good fundamentals that have decent possibility of catching upside. And, as you can see with the yields of these longs, I am getting paid to wait.

While I did add to risk-on, cyclical equity exposure in early October, the swiftness of the rally surprised me. I expected this type of rally to take five months, not three weeks. Stocks are overbought and due for a correction or consolidation. But on the dips, bulls should take a good look at some cheap tech stocks.

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