Gurus Think Tech Has Turned a Corner

For the first time, several technology heavyweights are passing my guru-based value screens.
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This column was originally published on RealMoney on Jan. 26 at 8:14 a.m. EST. It's being republished as a bonus for TheStreet.com readers.

Google did well last year, but many tech stocks didn't. The tech-heavy Nasdaq rose only 1.4% in 2005. Prospects look brighter this year. Corporate spending on technology is likely to increase and P/E ratios in the sector are fairly reasonable (Intel's is just 15.5). The stars and the moon may finally be in the right alignment for tech.

This is the first time in the two-and-a-half years since I perfected my guru strategies that several tech stocks have attracted my interest:

Dell

(DELL) - Get Report

,

Cisco

(CSCO) - Get Report

and

Intel

(INTC) - Get Report

. These three tech giants have grown earnings for a number of years, but their stocks have idled.

While Dell's earnings per share have grown steadily from 61 cents in fiscal 2000 to $1.18 in 2005, its stock has been stuck in the mud. Since approaching $60 in 2000, it has traded in the $20 to $40 range.

After a sharp plunge in EPS from $1.51 in 2000 to 19 cents in 2001, Intel has climbed the ladder every year since to $1.40 in 2005. The stock hit $80 in 2000, but for most of the last five years it has wavered between $20 and $35. Intel reported numbers last week that disappointed the Street, but note that earnings for the year rose over 20% from the previous year. Underlying growth is still strong. Analysts are saying Intel's growth this year won't be strong, but I don't put much stock in that -- I'm still a fan of this company.

The same holds for Cisco. EPS has grown from 36 cents in fiscal 2000 to 87 cents in 2005, but the stock went into a freefall after hitting $100 in 2000, and has been trading in a narrow range of the upper teens to low $20s ever since.

These stocks have gotten increasingly cheaper: Trailing P/E for Dell is about 23, 15.5 for Intel and 21 for Cisco. That's not dirt-cheap, but they are hardly pricey. This explains why these companies are now on the radar screen of the guru strategies. These are major corporations with long-term track records, great name recognition and solid market positions.

They became overpriced in the late 1990s as Internet fever hit, and have been shedding the price bloat they accumulated ever since. But by such traditional measures as P/E ratio, they are no longer bloated now. They've gotten themselves into shape and look ready to run a good race from here on out. This time next year, you may be sorry you focused only on Google and didn't pay attention to these fallen techies.

Intel

Apple has just started putting Intel inside its computers, the company has a solid market position and my screens based on the investment style of Peter Lynch indicate that this tech mainstay has a lot of room to make money. Its EPS growth rate of 35.9% (based on the average of its three-, four- and five-year EPS growth rates) fits nicely in the 20% to 50% growth range this strategy looks for. Its P/E (15.5) relative to its growth rate is a very good 0.43 (the Lynch strategy is particularly high on companies below 0.5).

Despite its high growth rate, inventories increased 0.39% faster than sales, however this strategy accepts a discrepancy of up to 5 percentage points.

Cisco

Another tech stock the Lynch strategy green lights is Cisco. It's not quite as strong as Intel, but it still looks like a buy.

With a P/E of 21.48 (well below the upper acceptable limit of 40), and a growth rate of 35.11%, Cisco's P/E/G is a respectable 0.61, well under the strategy's ceiling of 1.0.

Cisco has been able to reduce its inventories as a percentage of sales, even though sales rose a very strong 35.11%. That's impressive and shows management has considerable control over its inventories. Another plus is that Cisco has no debt (Intel has debt, but not much).

My strategy based on the investing style of William O'Neil also gives Cisco a thumbs up, though with not quite as high a rating. This strategy screens for companies with annual earnings growth above 18%, and preferably higher than 25%; Cisco's over the past five years was 19.3%. EPS should have increased every year for the past five.

O'Neil believes stocks trading within 15% of their 52-week highs could break out to a new high on above-average volume. Cisco was recently at $18.56, within 10% of the 52-week high of $20.25.

The O'Neil strategy looks for companies that cut debt -- as we said before, Cisco has none. Its return on equity is 24.4%, well above the minimum of 17%.

Dell

Dell gets the nod from the strategy I base on Warren Buffett. Whoa, you say, how can a Buffett-based strategy pick a tech stock? Buffett is famous for saying he doesn't understand tech and therefore doesn't invest in it.

Well, while Dell is considered a tech stock, it's really in the more mundane business of assembling and marketing products. Dell doesn't develop or make anything. It buys components from others, assembles them into computers and sells them. With printers, televisions and other electronics, it usually doesn't even do that. It just has a manufacturer put its name on the product and then it sells it. So, yes, a strategy based on Warren Buffett's investing philosophy could, in fact, like a "technology" stock like Dell.

Importantly, Dell fits the definition of a "Buffett-type company." It holds that crown because it is the largest company of its kind in the world. Buffett loves predictable earnings and Dell has had a steady increase in earnings per share each year for the last 10, with one exception.

It's also a conservatively financed company. With earnings of over $3 billion a year and debt of about $500 million, Dell could pay off its debt in about two months, which is exceptional.

My Buffett strategy screens for companies with average return on equity of 15% or better over 10 years, as these companies tend to have a durable competitive advantage; it further requires that ROE has remained over 10% each year and averaged over 15% for the past three. U.S. corporations have, on average, returned about 12% on equity over the last 30 years. Dell's average ROE over the last 10 years is a very strong 35.3% and it has never dipped below 25.3%. Its average ROE over the last three years was 43.0%.

To ascertain whether an investment prospect should be bought at its current price, the strategy averages two methods of calculating whether the rate of return on the stock would equal or exceed 15%. The two methods produce an annual compound rate of return of 16.5% and 27.5%, for an average of 21.9%.

Dell may be a tech stock, but with this high an expected return, don't tell that to Buffett.

Dell, Cisco and Intel are three of the grand old soldiers of the tech world. But they are still fit and trim, and highly experienced. Now looks like a very good time to add them to your army of high-performing stocks. Tech isn't dead, and these three companies prove it.

John P. Reese is founder and CEO of Validea.com, an investment research firm, and Validea Capital Management, an asset management firm serving affluent investors and companies. He is also co-author of the best selling book,

The Market Gurus: Stock Investing Strategies You Can Use From Wall Street's Best

. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Reese appreciates your feedback.

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