Big tech, small multiple

Big Tech valuations: Microsoft, Apple and Google – together worth over $650 billion – seem to have plenty of growth left in the tank, but it’s not evident in their stock valuations. The shares of all three tech giants, after accounting for their cash hoards, trade at a discount to the market. This phenomenon isn’t new. Investors shunned the sector for long stretches twice over the last 40 years, worrying that obsolescence might pre-empt expansion.

Intel, for one, can vouch for the experience. In the mid-1970s, shares of the rapidly growing chipmaker could have been bought for just six times earnings. Few tech investors seized the opportunity, however, because of a recent scarring.

A few years earlier, upstart mainframe companies like Control Data had been all the rage. IBM and Xerox boasted spots in the list of “nifty fifty” large-caps, whose growth was supposed to continue steadily unabated. Those bubbles popped when computer orders slowed and economic hard times hit blue-chips.

By the early 1980s, investors had regained their zeal for growth stocks. Hewlett-Packard, with its hot-selling desktops, was bid up to 28 times expected earnings. Intel regained favour, too, and was valued at a heady 60 times. Meanwhile, the S&P 500 index was trading at a mere multiple of 12.

Recession brought a fresh malaise at the end of that decade. Tech valuations on many smaller companies sank below even the cash on their books, according to Fred Hickey’s High Tech Strategist newsletter. Significantly, growth companies suffered along with industry gorillas. Compaq, a leader in the sizzling PC market, was expanding its bottom line by more than 60 per cent a year but traded at just nine times earnings, or about half the multiple of the broader market. It took another five years for tech stocks to rebound.

So, while Microsoft, Apple and Google look cheap today – at 7.5, 9.8 and 11.5 times their respective cash-adjusted earnings expectations for 2011, against 13 for the market – history suggests the discount could linger. A willingness by investors to bid up unprofitable companies like LinkedIn and Pandora means they’re not yet repulsed by the entire sector. As in earlier cycles, big tech stocks may need to wait until that day comes before they meaningfully climb again.