Tech stocks: Looking for value beyond faded stars


What is it about tech stocks? Why do we care so much about them? And in particular, why do we care so much about tech stocks that aren’t merely past their sell-by dates, they’re practically publicly-traded Superfund sites? Let’s round up a few of these war horses:

Microsoft (MSFT), the software behemoth that in the past 10 years spent $79 billion on research and development and came up with exactly one interesting product: Kinect. And just one problem with that – Kinect is part of Microsoft’s xBox effort that has never been profitable. Total annualized return over Microsoft’s last 10 full fiscal years? +2.9%, and most of that from dividends.

Cisco Systems (CSCO), once famous for obnoxiously beating earnings estimates by exactly one penny for years and years, now facing the existential threat of Software Defined Networking. Total 10-year annualized return? +3.0%.

Hewlett Packard (HPQ), whose demise is particularly fascinating to watch. A giant technology mastodon stuck in a tar-pit of trophy CEOs, technical hubris and congealed legacy. Remember the hand-wringing angst surrounding then-CEO Carly Fiorina’s decision to acquire Compaq?  That seems so 2002. Total annualized return since then? +2.9%.

Dell. Not even the return of its namesake founder has stemmed the dismal tide sweeping Dell toward the glue factory. Want a Dell tablet? Yours for only $759 MSRP. Smartphones? Nah. The Cloud. Eh, maybe. Total annualized return in its past 10 full fiscal years? -9.4%. Ouch.

By comparison, the S&P 500 annualized total return over the past 10 years has been +7.5%.

Of course, not all technology companies have sunk so low. IBM (IBM) stands as an exemplar of how to not merely be huge and survive, but thrive. At some point in the lengthy tenure of then-CEO Samuel Palmisano, Big Blue discovered that along with making computers and buying software companies, they could also manufacture earnings.

Witness IBM’s recently announced 3rd quarter, where revenue declined 5% year-over-year yet non-GAAP earnings per share rose 10% over the same time period. How did that happen? By trading cash for a) high-margin software companies and b) their own shares. IBM has bought back 50 million shares in the last year alone, causing its share count to decline about 4% in that time. IBM was $75/share ten years ago. It’s a little more than $200 as I type this.

Unsurprisingly, the four aforementioned companies, along with Oracle (ORCL), have attempted in the past few years to mimic IBM and its success. They’ve become one-stop vendors for hardware, software and services. Oracle bought Sun Microsystems. Dell bought Perot Systems. Hewlett Packard bought Electronic Data Systems.

But that kind of “systemic” transformation requires more than a checkbook. It requires management skill. Is that at hand? Hewlett Packard has churned through CEOs like some kind of organizational wood chipper. Currently at HP’s helm is former eBay CEO Meg Whitman, who unforgettably characterized her tenure at the on-line auction giant by stating that “a monkey could drive this train.” They say it’s better to be lucky than smart, but what if evidence suggests, as it does for Ms. Whitman, that you might be neither?

Real technical innovation is happening outside of traditional (read: “electronic”) technology. In Biotechnology. In robotic medicine.  In energy (fracking). In specialty chemicals. But the poor investment returns of our four examples are probably due in large part to these firms’ utter lack of innovation. None of our four companies has distinguished themselves in recent years. They’ve spent unwisely on R&D, and have instead ridden early leads (Microsoft), purchased others’ innovative products (Cisco) or spent virtually nothing at all (Dell).

But innovation is what allows a company to have higher profit margins, because it means they alone possess something useful, novel and non-obvious (the three elements of a patent claim, by the way) and can therefore charge more for it.

Did investors ever really care about Dell because they were spending an average of 1% of revenue on research and development every year? Heck no. They cared because Dell was a tech stock and was going up like a bottle rocket in the late 80s and early 90s. Now? Dell is just an industrial supplier (yawn). But still, Maria B. wants to break into her regularly scheduled programming to give you the earnings numbers.

As a technology portfolio manager, I’m immensely glad that the media still cares about these old ponies, inasmuch as it keeps my competitors’ money tied up in under-performing assets. We own IBM in the technology portfolio we manage on Covestor, and we’re always on the lookout for companies that are low on fame and high on cash flow – as opposed to these former stars, now trading on long-ago glories.

Who will be tomorrow’s war horses? Apple?  Intel? Facebook? Oracle? List your favorite in the comments below.

Certain investments discussed in this presentation are for illustrative purposes only and there is no assurance that the adviser will make any investments with the same or similar characteristics as any investments presented. The investments are presented for discussion purposes only and are not a reliable indicator of the performance or investment profile of any composite or client account. Further, the reader should not assume that any investments identified were or will be profitable or that any investment recommendations or that investment decisions made by model managers in the future will be profitable.

Any index comparisons provided in the blogs are for informational purposes only and should not be used as the basis for making an investment decision. There are significant differences between client accounts and the indices referenced including, but not limited to, risk profile, liquidity, volatility and asset composition. The S&P 500 is an index of 500 stocks chosen for market size, liquidity and industry, among other factors.

Certain of the information contained in this presentation is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. The manager believes that such statements, information, and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.

Author profile

Barry Randall
Barry Randall
Crabtree Asset Management invests in growing technology companies. Barry Randall is the firm's founder and chief investment officer. He has more than 20 years of professional investing experience.

Barry spent five years as a technology stock analyst and 10 more years managing mutual funds that focused on small-cap and technology stocks. He has experience managing mutual funds and separately managed accounts as large as $650 million. Prior to earning his MBA in 1993, he spent six years as a professional computer programmer.

Barry earned a Wall Street Journal 'Category King' award for his co-management of a small cap mutual fund in 2006.

As of December 2016, Morningstar rated the Crabtree Multi-Cap Technology composite, of which the strategy offered at Covestor is a component, as having four stars (out of five) for its overall and trailing 5-year performance.

Barry has been quoted regularly in Forbes, US News & World Report, TheStreet.com and E-Commerce Times. He has appeared on CNBC, Bloomberg TV and Fox Business News.

Crabtree Asset Management LLC was founded in 2008 and is headquartered in Saint Paul, Minnesota.