In the long run, everything is a toaster. This is one of the more memorable lines delivered by Professor Bruce Greenwald, who teaches the class in value investing at Columbia Business School that was once taught by Benjamin Graham, and taken by Warren Buffett.
The comment is a classic put-down by value investors against the overhyped hopes of rival “growth” investors. Great innovations may make money for a while, they say, but eventually they will be commodified and compete on price, like everyone else – much like a toaster.
It was a useful rejoinder during the tech bubble of 1999 and 2000, when value investors were briefly swamped. Tech stock valuations of the time made no sense.
But now, value investors seem to be treating the comment as a call to action. Some of the biggest and most famous names in technology are beginning to look very much like toaster-manufacturers, or at least the market is treating them that way – and value investors sense an opportunity.
In other words, Big Tech might actually now classify as a value investment. Eye-catching performance by companies such as Google, whose share price recently breached $1,000 for the first time, tends to obscure the fact that the S&P technology sector has been underperforming the market as a whole for more than a year. Many big and established names look cheap.
Perhaps the most dramatic example is Cisco Systems, fleetingly the world’s most valuable company back in 2000, when Mr Market decided to give it a multiple of more than 200 times its earnings. Back then, the company had a great future ahead of it, and its earnings per share are now five times greater. But its share price remains almost 75 per cent below its all-time high.
Its price to earnings multiple now, at about 15, is lower than that of the S&P 500 (at about 18), and, remarkably, even slightly lower than that of the S&P’s utilities index. Cisco’s routers, it would appear, are being priced by the market as though they were toasters.
Richard Bernstein, lead manager of the Value Equity fund for Baltimore-based Brown Advisory, who holds Cisco, says the company, which now pays dividends, has admitted it has more capital than it can use, has strengthened its core business and looks cheap. Toaster-makers can still make great investments if they are well run and attractively priced, and Bernstein says Cisco now fits the bill.
Cisco does appear on some screens as a value stock. For example, it makes up 0.09 per cent of the FTSE-World Value index (but bulks larger, at 0.27 per cent, in the FTSE-World Growth index). But another intriguing name that does not yet have any weighting in FTSE’s value index is also attracting attention of value managers: Apple.
Arguably, Apple Macs and iPod Classics are already toasters. It looks early, however, to try to extend this argument to iPhones or iPads, even if both face tougher competition than they encountered in the first year or two of their existence.
The share price briefly topped $700 last year, before running into a storm. It now stands at about $526. And on commonly used metrics, Apple looks like a genuine value stock. Growth in revenues and earnings during the early years of iPhones and iPads was genuinely phenomenal, and drove up the share price – but valuations showed that the market was never convinced that the revenues were sustainable.
Add to this another factor beloved of value investors: a strong balance sheet. Apple’s balance sheet is so strong, with $146 billion of cash, as to become virtually a political issue. Strip out that cash, and Bernstein points out that the market is pricing Apple at roughly 8.5 times its earnings. Big names in the value investing world, such as David Einhorn of Greenlight Capital in New York, have also taken big stakes in the company.
The toaster analogy, when taken a little further, might show why people are still nervous to treat tech companies as value plays. A true value investment, after all, needs a margin of safety if the worst comes to the worst. Or to use the Buffett phrase, it needs a “wide economic moat,” as can come from a government monopoly or a strong brand.
Just in the past 20 years, the tech sector has provided several examples of gadgets that at one point seemed to have all the trappings of a strong brand, but which are now not even as valuable as a toaster. Palm Pilots, Psion organisers, Motorola RAZR phones and, it appears, BlackBerrys are all on this list – once dominant, but with brands that are almost worthless. If only their manufacturers had switched to making toasters in time.
But the multiples being applied to Cisco routers – which are not visible to consumers in the same way as these products, and seem to be far better protected – or even to Apple products, which are boosted by a huge ecosystem of electronic retailing that keeps subscribers loyal, still imply that these products are ex-growth, when there is a good chance of more growth to come.
Big technology companies, with their high public profile and large market caps, are unusual candidates to be value stocks. But in this case, the value may be hidden in plain sight. Either way, it is time to consign the dotcom bubble to the history books. Technology has matured, and the market looks as though it may have exaggerated the extent to which it has matured. There is good reason to expect more interest from value investors in large technology stocks.
Copyright The Financial Times Limited 2013