Tech stocks are undoubtedly at risk of overheating after a great run in 2013. But finding cheap stocks to buy in the technology sector isn’t impossible … if you know where to look.
Sure, social media is full of froth, with LinkedIn (LNKD) sporting a forward P/E of almost 100 and recent IPO Twitter (TWTR) racing up over the holidays. Finding cheap stocks to buy in this corner of the tech sector seems nigh impossible.
Elsewhere among tech stocks, you’ve got once-battered players like chipmaker Micron (MU) that have soared by triple digits in short order on turnaround hopes. No luck there, either.
But there are thousands of tech stocks of numerous flavors, and not all picks have run up to extreme valuations just yet.
If you are looking for cheap tech stocks to buy, you have to look at unsung companies that have been overlooked by the rest of Wall Street. And it also helps if you have the patience for dividends and long-term growth instead of the desire to snag a short-term momentum trade in a fashionable name.
Consider these five cheap tech stocks as bargain buys for the New Year:
Cheap Tech Stocks: IBM
P/E: 10.3 based on FY2014 earnings
Dividend Yield: 2.0%
Dividend Payout Ratio: 21% of FY2014 earnings
IBM (IBM) is hardly on a lot of investors’ tech stocks watch list, with a share price that is actually in the red over the last 12 months vs. a roaring bull market for the rest of Wall Street in general and tech stocks in particular.
And the reasons are obvious: Businesses are squeezing profitability out efficiencies instead of growth, and enterprise tech just hasn’t seen the amount of spending some expected.
But in 2014 and 2015, businesses will assuredly begin the upgrade cycle again if they want to actually see organic growth. Furthermore, if the economy continues to mend then the opportunity to hire and expand operations will be more obvious and pressing.
IBM is playing on this cyclical recovery trend, since it is one of the largest enterprise tech plays out there. Only two U.S. tech stocks, Apple (AAPL) and Microsoft (MSFT), record more in annual profits than IBM. And only Apple and Hewlett-Packard (HPQ) record more in annual revenue.
IBM sports a decent 2% yield that is a mere 21% of earnings, and the company has paid a dividend since 1916 so you can have faith this company knows how to pay its shareholders. On top of dividends, a $15 billion stock buyback plan should boost EPS and keep prices firm going forward.
Cheap Tech Stocks: Seagate Technology
P/E: 10.4 based on FY2014 earnings
Dividend Yield: 3.0%
Dividend Payout Ratio: 31% of FY2014 earnings
Seagate (STX) is a disk drive company that many think is past its prime at first glance. But given the 85% run in the last 12 months, STX stock clearly isn’t dead yet.
Furthermore, earnings continue to grow … and even after this big run, shares are very reasonably priced compared to other tech stocks with a forward price-to-earnings ratio of about 10.
Throw in a sustainable dividend that yields 3% and you’ve got a pretty good long-term tech stock.
The disk drive industry can be volatile, but the bottom line is that Seagate is still cranking out a lot of hardware. After all, though “the cloud” is en vogue, it’s a painful reality that information has to live somewhere, and Seagate drives are a big part of data centers as well as consumer devices.
In the age of big data, STX stock is a good play going forward. And given its cheap valuation and decent dividend, investors can have confidence even after a run-up in shares across 2013.
Cheap Tech Stocks: Microsoft
P/E: 12.5 based on FY2015 earnings
Dividend Yield: 3.0%
Dividend Payout Ratio: 36% of FY2015 earnings
While Microsoft (MSFT) is still transitioning to the post-PC age, there is a lot of potential left at this tech giant as it gets its sea legs in the smartphone and tablet space.
There’s still a long way to go for MSFT to catch up to other tech stocks in the mobile space, but the company is starting to make the right moves. The departure of long-time CEO Steve Ballmer will allow MSFT to make some changes in strategy necessary to evolve the business, and with $80 billion in cash and short-term investments this is a company with plenty of dry powder to make moves in the next year or so.
Throw in a merger with the hardware unit of Nokia (NOK) alongside the failing BlackBerry (BBRY) business, and it’s clear that Microsoft has a lot of opportunity to unlock mobile market share in 2014 and beyond. IDC recently predicted the Windows Phone market share of the smartphone market will jump to more than 10% of all smartphones by 2017 — up from roughly 2% in 2013.
A robust dividend gives investors plenty of insulation against short-term volatility, too.
Cheap Tech Stocks: Cisco
P/E: 11.0 based on FY2014 earnings
Dividend Yield: 3.1%
Dividend Payout Ratio: 34% of FY2014 earnings
Another underperforming enterprise tech play to consider is Cisco (CSCO). It may not have the reach of IBM, but performed a bit better in 2013 — 10% gains vs. a negative return for IBM — and boasts a slightly higher dividend.
Right now, research firm Gartner is predicting a 3.1% growth rate for total IT spending worldwide — up from a basically flat 0.4% growth rate in 2013 and a modest 1.2% growth rate in 2012. Enterprise software and data center spending are among the stronger segments for 2014 — so even if PCs are fading, software sales are not.
Furthermore, as we saw with auto sales, you can only delay purchases so long before pent-up demand spills over to boost tech stocks like CSCO again. If consumers were wooed back to auto showrooms thanks to affordable vehicles sporting back-up cameras and amazing media capabilities, it’s reasonable to think that businesses will eventually be wooed back to enterprise technology as the increased speed and functionality of newer software makes the investment a no-brainer.
And once again, I’ll point out that this cyclical potential comes tapered with significant dividends to hedge your bets. Tech stocks Hewlett-Packard, IBM and Cisco all boast between 2% and 3% in dividend yield. And all boast payouts between 20% and 35% of 2014 profits, meaning dividends are sustainable and ripe for future increases.
Cheap Tech Stocks: Hewlett-Packard
P/E: 7.8 based on FY2014 earnings
Dividend Yield: 2.1%
Dividend Payout Ratio: 16% of FY2014 earnings
Hewlett-Packard (HPQ) doubled in 2013, so you may not think it’s one of the cheap tech stocks. However, even after this huge run HPQ still has a forward price-to-earnings ratio of less than 8.
Furthermore, HP sports over $12.1 billion in cash on the books. When you back out the cash, the P/E falls to about 6. That’s crazy cheap!
And despite volatility in recent years, HP is a rock-solid company with operating cash flow topping $11.6 billion in fiscal 2013. HPQ stock pays a nice 2% dividend and has tons of headroom to increase those payouts going forward. And considering the distributions have almost doubled in the past 10 years, it’s clear that dividend growth is a big part of the company’s mission.
Sure, HPQ has had trouble growing revenue in a post-PC age. And there is a risk that some of the turnaround has been priced in after the 2013 run-up.
But HPQ stock is showing signs of a transition to more software and enterprise sales that hold potential. On top of that, it’s still a cheap tech stock based on forward earnings, and the dividend is bulletproof so you will have a good foundation even if shares do drift sideways for the short-term.
As of this writing, Jeff Reeves did not hold a position in any of the aforementioned securities.