It’s Hard to Switch
Oracle, which is one of the big positions owned by GMO's co-founder Jeremy Grantham, is multinational technology corporation that specializes in computer hardware systems (like servers, storage products and networking components) and enterprise software products (mainly database related). The firm holds a leading position in the growing enterprise software market, and is expected to increase its market share with the rising adoption of Oracle’s engineered systems (bundled products containing multiple elements of Oracle software and hardware). Trading at $32 or 14.5 times its earnings, Oracle shows a high level of operating cash flows and offers margins and returns above the industry average. Is it a buy? Maybe.
The firm’s fourth quarter results reported poor sales, which made Oracle’s stock plummet in late June. Analysts worried about the tiny growth on new software licenses revenues (1%), as this is a closely watched indicator of the company’s future revenue. Yet, investors shouldn’t panic nor discard Oracle as a solid investment option.
As said, the firm enjoys a market-leading position in enterprise software, which has incredible switching costs, and should benefit from the increasing global expenditure on database management systems, which is expected to take place in the near term. In addition, in the long term the company is expected to benefit from the increasing spending on SaaS (software as a service: a delivery model where the software and its data are hosted on the cloud) and cloud-based services, which should boost Oracle’s top-line growth.
On the down side, besides the recent uneven performance, it should be said that although Oracle currently dominates the database market, open-source databases (like Ingres and PostgreSQL) typically used in small business, could pose an important threat in the future.
Bing or Bang?
Microsoft is one of the world’s largest software firms and one of those companies that does not need an introduction. Renowned hedge fund managers like Larry Robins and Jeff Ubben have jumped on this stock recently, although the firm's recent performance may discourage some investors. The thing is that Microsoft has been struggling with shifts in consumer’s preferences, as the PC market — where it holds a dominant position — has been declining rapidly, and is hasn’t yet been able to perform soundly in the rising mobile device market.
Microsoft reported disappointing fourth quarter results, with revenues widely missing analysts’ expectations, which made the stock decline by over 11%. Trading at $33 or 12.7 times its earnings, does Microsoft offer an attractive entry point? I’m not convinced.
The vast majority of Microsoft’s operating income (72%) comes from the PC industry, which according to IDC is experiencing its fifth consecutive quarter of declines. With the secular shift from desktop computers to mobile computing devices, the Windows segment (which constitutes 25% of the Microsoft revenues) needs to do a better job at positioning itself in tablets and smartphones. This won’t be an easy task, as Microsoft is under increasing competition from other tech giants such as Google and Apple.
On the upside, Microsoft’s server and tools businesses, which also generate about a quarter of Microsoft’s revenues, remain strong and are expected to continue gaining market share, as it benefits from the rising move to cloud computing. The segment’s revenues have grown in double digits for the last three fiscal years, and it has solid growth prospects ahead.
Cisco Systems, present for a long time in the portfolio of investing legend Donald Yacktman, is a multinational tech company that focuses on networking equipment. The firm has been increasing its sales, operating profitand net income for more than a decade, driven by growing revenues in the routing and switching markets where it is the No. 1 player. Cisco’s third quarter results beat analyst estimates, with EPS up 15% year-to-year. Having gained over 30% during this year, it trades at $24 or 13.1 times its earnings, a massive discount to the industry average, and yields 2.6% of its current valuation in the form of dividends.
Cisco’s prospects in the routing and switching markets, which account for two thirds of its product revenue, look solid. The company has held over 60% of the switch market for the last five years, which provides it scale advantages its smaller competitors lack. A similar situation occurs in the routing market were, although its dominant position isn’t as pronounced, Cisco’s leading position still remains unchallenged. With Internet traffic increasing strongly each year, the demand for Cisco’s Ethernet switches and routers should continue growing.
On the down side: The long-term effects that cloud computing may have on the company still remain uncertain and could certainly deteriorate Cisco’s gross margin. Yet the company certainly looks strong right now, and there are no immediate threats in the horizon.
While all three companies certainly have some interesting opportunities ahead, my bet here is on Cisco. The firm has been performing strongly. It’s a dominant player in the growing switching and routing markets, and offers a nice dividend. I'd say Cisco is a pretty safe bet.
Disclosure: Damian Illia holds no position in any stocks mentioned.