DellJoe Raedle
When you think of hot technology stocks, Dell Inc. and Microsoft Corp. probably don't spring to mind: They tend to be associated with products that consumers find, well, a little boring.
"Say you have two kids, and you give one an Apple iPod and the other a Microsoft Zune," said Carl Lytollis, head of U.S. equities at Phillips Hager & North Investment Management. "The kid who got the Zune would think you didn't like him."
Investors seem to agree with the kids. Over the past five years, Microsoft shares have flat-lined and Dell shares have been cut in half – but red-hot Apple Inc. shares have surged about 350 per cent with the success of the iPod, iPhone and iPad.
However, some investors have begun to notice that this consumer-centric approach to technology stocks ignores one very important aspect: Some technology companies are geared far more toward corporate spending than consumer spending.
Indeed, companies such as Dell and Microsoft might be out of favour with consumers, but they are still go-to names when corporations upgrade their technology infrastructures, making them ideally positioned for a much-anticipated rebound in corporate spending.
"A lot of companies are still running Windows XP," Mr. Lytollis said, referring to Microsoft's 10-year-old operating system. "At some point, you have to get off that operating system and do a system-wide upgrade."
Observers had thought that this corporate upgrade cycle would have happened sooner with a more dramatic rebound in spending, but an apparent lack of confidence in the economic recovery has slowed things down. In the meantime, corporate coffers are swelling, with Bloomberg News estimating that S&P 500 companies are sitting on about $2.4-trillion (U.S.) in cash and short-term investments.
However, Dell's most recent quarterly results hint that businesses are beginning to make upgrades. Dell sailed past analysts' earnings expectations, largely because analysts underestimated the corporate side of its business.
"The money in PCs isn't in selling them one-by-one at Best Buy, but by selling them in batches of thousands," said Tom Smith, an analyst at Standard & Poor's, who recently upgraded his recommendation on Dell to "buy" from "sell." "That stream of demand has come back on."
As well, legendary investors Mason Hawkins and Staley Cates of Southeastern Asset Management – Dell's biggest shareholders outside of founder Michael Dell – pointed out in their recent quarterly report to clients that the company's growth is tied to its strength in servers, storage and services to businesses, government and health care organizations.
Sexy? No. Profitable? Very. In this way, Dell has borrowed a page from International Business Machines Corp., the technology company that struggled in the early 1990s before focusing on higher-margin corporate and government customers.
Microsoft is in a similar situation to Dell. Outside of the Xbox gaming console, Microsoft has had few successes in its appeal to consumers – a fact underscored when Apple recently surpassed it as the world's biggest technology company, based on market capitalization.
Yet Microsoft's most recent quarterly earnings blew past expectations, and it wasn't because consumers suddenly embraced its software or tech toys.
Instead, UBS analyst Brent Thill noted recently that the results were a "testament to the diversity of its business model and the power of its enterprise product cycle."
In other words, corporations had begun to open their wallets and Microsoft is a company that remains at the centre of corporate spending. Mr. Thill expects this trend is the start of a multiyear process that will drive up the valuation on Microsoft's stock, which currently trades at just 10.5 times estimated earnings.
Dell and Microsoft might not be on the verge of turning cool with consumers. But for investors, a rising share price is a far better transformation.
David Berman