Old Tech and New Tech : Wrong Question.

Today's WSJ continues the quest to reconcile the ridiculous valuations of recent IPO's like LinkedIn with the current valuations of tech behemoths like Apple, HP, Microsoft, Google and IBM. It's the wrong optic, turned on the wrong set of questions.

These two segments of the market have nothing to do with each other, and broadly speaking, the players who populate these markets are operating under different charters. As we've written about before, every kind of investor wants to get in on the circus of a hot IPO. Flipping is the name of the game, encouraged by the underwriters fanning the flames. Once the IPOs are out in the market place, the game changes and a different mix of players emerges, including those awaiting a small pop from analyst initiation reports, presumably at "Strong Buy."

Investors playing in the seasoned tech equities, as we've written about, are the traditional institutional investors, which now include both growth and value investors. However, the newspaper articles quoting pundits opining about "growth" have it wrong also. It's all about returns, and about risk.

Apple, which has doubled its share price in each of the past five years inevitably had to take a pause and even pull back, in relative terms. It had become a cult stock, and everybody knew about iTouch, iTunes, iPad, iMac and about the slew of competitors who could only play catch up. Questions about Apple's leadership succession have to weigh on the stock. If indeed Apple=Steve Jobs, then it's time to head for the exits. Since no other story has been forthcoming, why not take the money and run, i.e. sell the stock and buy something cheaper?

We know that corporate disclosures for post retirement benefit plans have long included projected returns for equities of 8 percent or better. We know that the decade ended 2009 had stock returns of zero for the broad indexes. Now, everyone is rightly saying how can we continue to project equity returns of 8 percent? So, for the sake of argument, let's say that the projected return on equities for the next ten years is 5 percent, without getting into all kinds of complexities like emerging markets for the moment.

Microsoft has a forward dividend yield of about 2.5 %. This means that to get a return of 5%, an investor would have to get only 2.5% from price appreciation, arising from either higher earnings, higher valuation ratios or some combination. Let's say that US GNP grows at 1-2% per year for the next ten years. MSFT should be able to grow earnings, even at the same valuation, at a GNP growth rate or better. Unless, something like a 100 year storm were to hit--like losing 100 percent of its Office franchise or losing its SQL server business. Even in ten years, how likely is this? This is a risk question. I don't know the answer, to be sure, but I also don't know anyone who does, and that includes bloggers, tech gurus and talking heads. So, even if earnings don't come through, and the dividend were to increase modestly, an investor would have a positive return with seemingly little downside risk.

This is the kind of reasoning that underlies the Tweedy Browne comment that Microsoft is "statistically cheap." Of course, they also refer to the fact that the returns on MSFT's consolidated businesses are still enormously high, even with the current P/E of 9. So, the question is not "growth or no growth," but "market or better return" with "below market risk."
This is the value investor's lens, and it's always been a good one, and it is now especially in these frothy times.