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5 Cheap Blue Chip Technology Stocks

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Magic Diligence

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Taking a look at the large-cap screens from Joel Greenblatt's Magic Formula Investing (MFI) screen and one thing jumps out - the number of large, blue chip tech firms that show up. To be sure, MFI can screen stocks for the wrong reasons. One-time, non-recurring revenue windfalls can distort both earnings yield and return on tangible capital, the two statistics used by the strategy to rank stocks. The strategy is not immune to screening up stocks with poor balance sheets from time to time. And, of course, some companies deserve to be priced cheaply, owing to a clearly failing business model as new trends or technologies take over for their once-attractive products or services.

None of these are the case with the 5 tech firms I'm going to talk about below. All are current MFI stocks with legitimately low stock prices and legitimately high returns on capital. All have solid balance sheets and over half pay a dividend. All sell well below even their 5-year average *low* P/E ratio. And while the consumer PC has likely seen its heyday, tech is far from a dying industry. Mobile computing devices are growing rapidly. Enterprise and emerging consumer demand for cloud services is leading to rapid build out of huge data centers. And to transmit data between the two, service providers are trying to keep up with massive data traffic growth with new IP network infrastructure. All of these trends point to future growth for these firms - not the declines they are priced for.

Here are the 5 blue chip tech firms that look like great investments at current prices:

Dell (DELL)

Current Earnings Yield: 18.2%

5-year Average Earnings Yield: 10.5%

Current P/E: 7.6

5-year Average Low P/E: 12.2 Why It's Too Cheap: Here's a simple illustration. Trailing 12-month operating earnings are $4.5 billion. For fiscal 2007 (basically calendar 2006), total operating earnings were $3.1 billion, yet the stock price hovered in the mid-20's. The market was wrong then, and its wrong now. Dell's current operating margin of 7.3% is far above its historical 5.5% average - a huge difference on a $60 billion dollar revenue base. And with the firm's new focus on services, software, and data center products, higher margins should be sustainable. Dell has a great balance sheet and generates voluminous free cash flows. The company also stands to benefit from the uncertainty around Hewlett-Packard's (HPQ) PC unit.

Microsoft (MSFT)

Current Earnings Yield: 14.7%

5-year Average Earnings Yield: 9.5%

Current P/E: 9.5

5-year Average Low P/E: 11.4 Why It's Too Cheap: Looked at without emotion, Microsoft's financial performance over the last 5 years has been solid. Revenues have expanded 37%, operating income is up over 50%, and earnings per share has nearly doubled, while the dividend has grown 56%. Yet the stock has done little. 12-15% annual sales gains in the Business and Server/Tools divisions are ignored while 1% declines in the Windows business (2 years after a new release) are extrapolated into disaster scenarios. Upcoming Windows 8 looks quite attractive as a tablet option, and MSFT is in good position to gain share in the smartphone market due to Google's (GOOG) move into hardware. And that's saying nothing of Microsoft's citadel of a balance sheet, big share buybacks, and steadily rising dividend.

SanDisk (SNDK)

Current Earnings Yield: 19.6%

5-year Average Earnings Yield: about 7%

Current P/S: 1.65

5-year Average P/S: 1.9 Why It's Too Cheap: The two big growth markets in consumer electronics are smartphones and tablets. Both are built on flash memory. A major trend in PCs is toward ultra-thin designs, like Apple's (AAPL) Macbook Air. Those designs depend on flash memory (not hard drives) for storage. SSD flash drives are an important part of data center design due to their speed and low power requirements. SanDisk is the purest play in flash memory. Revenues are growing at near 20% annual rates, and margins have improved sustainably due to a shift into product-embedded flash rather than consumer SD cards. So why is this cyclical stock selling at historically low price-to-sales multiples? It doesn't add up.

Cisco (CSCO)

Current Earnings Yield: 13.9%

5-year Average Earnings Yield: 8.3%

Current P/E: 13.1

5-year Average Low P/E: 14.3 Why It's Too Cheap: It's true: Flip, Scientific Atlanta, and Linksys were probably mistakes in hindsight. And public sector IT spending (about 20% of Cisco's revenues) will continue to be weak for some time to come. But the market's fears of Cisco losing significant market share in switches to HP and in routers to Juniper (JNPR) have not been realized. In fact, both of those firms are now reporting weak results just like Cisco did 9 months ago. The firm returned to sales growth in Q4 and margins seem to be stabilizing. A renewed focus on areas where the company has sustainable competitive advantages and $1 billion in operating cost cuts should return operating profitability to historical norms near 25%. Cisco has always bought back prolific numbers of shares and now pays a dividend to boot. And it's not like network traffic has flat lined... the Internet is still experiencing 30-40% year-over-year traffic increases! With the proliferation of "smart" devices, this trend doesn't look to slow down anytime soon.

Intel (INTC)

Current Earnings Yield: 16.5%

5-year Average Earnings Yield: 9.2%

Current P/E: 8.8

5-year Average Low P/E: 14.6 Why It's Too Cheap: Intel's low valuation doesn't really match up with results - 2011 estimates are expected to show a 24% revenue and 13% operating income rise from 2010's already solid result. Investors are worried about the firm's weak position in mobile devices vs. ARM Holdings (ARMH), and also the slowing consumer PC market. But there are two sides to this trend, and Intel is well positioned to benefit from the "cloud" side demand for server and storage devices. Intel's platform strategy has led to the firm gaining an increasing dollar share of PC components - for example, the "Sandy Bridge" platform requires the PC OEM to use Intel's graphics solution instead of competing offerings from Nvidia (NVDA). Finally, there is classic downside protection in the form of a large 4.3% dividend yield. This may be the most interesting choice in this attractive basket of tech stocks.

Disclosure: Steve owns DELL, MSFT, SNDK, INTC

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Magic Diligence
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