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For all of the bearish talk about Microsoft over the years, the company has continued to produce results. (Dado Ruvic/Reuters)
For all of the bearish talk about Microsoft over the years, the company has continued to produce results. (Dado Ruvic/Reuters)

Tech

Three undervalued tech stocks to buy and hold Add to ...

John Reese is CEO of Validea.com and Validea Capital, and portfolio manager for the Omega Consensus funds. Globe Investor has a distribution agreement with Validea.ca, a premium Canadian stock screen service. Try it.

Uh-oh – is Nobel Prize-winning economist and renowned bubble spotter Robert Shiller seeing a new bubble in the tech sector? That’s what some recent headlines would have you believe, after Mr. Shiller – one of the few who warned of both of the Internet bubble of the late 1990s and the housing bubble of the mid-2000s – said on CNBC that “people are very impressed by high tech, probably too impressed, and so it does call to mind a bit of the late 1990s with the dot-com bubble.”

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But if you dig just a little deeper, Mr. Shiller does not seem to be calling a sector-wide bubble. In fact, in another recent interview, he said that the tech sector is one of the four cheapest sectors in the market right now, based on its 10-year cyclically adjusted price-earnings ratio.

Mr. Shiller also said that he likes “to look at long-term earnings. … I’m more of a stable investor who looks at long history and looks to invest long-term.”

I am of the same mind as Mr. Shiller, in a couple of ways. First, I like to focus on companies that have strong, longer-term track records; the Guru Strategies I use to invest in stocks look back as many as 10 years into a company’s earnings history before giving it the thumbs up.

Second, like Mr. Shiller, I think there are a lot of undervalued tech stocks right now, particularly among the “old school” tech firms. While they were once the hotshot darlings of the tech world, today many investors view these companies as old, stodgy and unexciting – and that’s just fine. Because, while they’re not producing gangbusters growth any more, they are still running very strong businesses. They trade at very attractive valuations – unlike many of those new high flying tech stars, whose P/E ratios in some cases are more than 100 (or incalculable because they don’t actually have any earnings).

Here are a trio that my strategies are particularly high on right now. As always, you should invest in stocks like these as part of a broader, well-diversified portfolio.

Microsoft

While many have suggested that Microsoft’s best days are far behind it, my Warren Buffett-inspired model doesn’t think so. That’s because, for all of the bearish talk about Microsoft over the years, the company has continued to produce results. The model looks for firms with lengthy histories of earnings growth, manageable debt, and high returns on equity (which is a sign of the “durable competitive advantage” that Mr. Buffett is known to seek).

Microsoft delivers on all fronts. Its earnings per share have dipped in only two years of the past decade; it could pay off its $20.7-billion (U.S.) in debt in less than a year, if it wanted to, given its $22.8-billion in annual earnings; and its 10-year average ROE is an impressive 32.4 per cent. And its shares are very reasonably priced, trading at a 7.2 per cent earnings yield.

Cisco Systems

Cisco gets strong interest from my Peter Lynch-based model. Lynch famously used the P/E-to-growth ratio to find attractive stocks, adding dividend yield to the “growth” portion of the equation for big, dividend paying firms like Cisco. When we divide Cisco’s 14.2 P/E by the sum of its growth rate (11.4 per cent) and yield (3.5 per cent), we get a yield-adjusted PEG of 0.95. Anything under 1.0 is considered a bargain.

Another reason the Lynch model likes Cisco: The firm’s reasonable 31-per-cent debt-to-equity ratio.

Cisco also get strong interest from my James O’Shaughnessy-inspired value approach. When looking for value plays, Mr. O’Shaughnessy targeted large firms with strong cash flows and high dividend yields. Cisco is plenty big enough, has $2.04 in cash flow per share (versus the market mean of $1.61), and has that solid 3.5-per-cent yield, so it makes the grade.

Oracle

My Lynch-based model is high on Oracle. It likes the firm’s strong, 20-per-cent long-term earnings growth rate, its very reasonable P/E of 16, and its 1.3-per-cent dividend yield, which make for a 0.76 yield-adjusted PEG ratio. My Buffett-based model is also a fan of Oracle. It likes that the firm has increased EPS in every year the last decade, has enough annual earnings (nearly $11-billion) that it could pay all of its debt (about $22-billion) in about two years, and has averaged an ROE of 23.7 per cent over the past decade.

Disclosure: I’m long CSCO and ORCL.

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