Finding Bargains Is Harder, But Not Impossible

Finding Bargains Is Harder, But Not Impossible

The stock market has been on an incredible run since the depths of the financial crisis, more than doubling in less than five years. While the stock market going higher is generally a good thing, one unfortunate side effect is that bargain stocks tend to become increasingly rare. Warren Buffett said as much in a recent interview with CNBC:

They're probably more or less fairly priced now. We don't find bargains around, but we don't think things are way overvalued, either. We're having a hard time finding things to buy.

Buffett's "circle of competence," however, doesn't extend to many areas that seem to be offering the biggest bargains right now. One of those areas is technology, which Buffett mostly avoids. While bargains are certainly less plentiful today than they were a few years ago, there is still value to be found in the market.

Apple: Still selling lots of phones
blew past sales estimates by selling 9 million iPhones during the first weekend after the iPhone 5s and 5c were released. This obliterates the 5 million iPhone 5 phones that Apple sold during the release weekend last year, quieting any critics who claim that the iPhone is losing its luster.

Apple is valued at about $450 billion, and with profits declining last quarter, uncertainty surrounding future profits seems to be preventing the stock from fully recovering. At about $490 per share, the stock is well below the all-time high of around $700.

Apple has roughly $130 billion in net cash and investments after subtracting its debt, bringing the enterprise value down to $320 billion. While the net income in fiscal 2012 was $41 billion, profits have so far declined this year. Net income over the last 12 months is about $37 billion, and it's hard to say when the profit will bottom.

What if profits fall to, say, $30 billion per year? Well, 15 times that number is $450 billion, plus the cash brings us to $580 billion. That's nearly 30% above today's market capitalization, even with a significant decline in profitability. The key for Apple is to stabilize its earnings -- only then will a reasonable multiple become possible.

I'm not going to try to predict the impact of an iWatch, or whatever else Apple has planned for the future. Apple's huge cash balance provides a substantial margin of safety, and even a serious decline in earnings, once stabilized, can lead to a far higher stock price. So while there is plenty of uncertainty regarding the future of Apple, there is much less risk.

Microsoft: It's all about the enterprise
There are plenty of concerns being voiced regarding Microsoft . The shift to tablets and smartphones threatens the cash-cow Windows and Office businesses that provide most of Microsoft's profits, and Windows Phones and Windows-based tablets have been slow to gain market share. Google's office software is viewed as a real threat to Microsoft Office, and many consumers are opting to eschew Microsoft Office altogether.

But Microsoft is not really a consumer company. Its enterprise business is key, and it's there that Windows and Office reign supreme. That's not going to change anytime soon, and all of the threats on the consumer side barely register on the enterprise side.

Like Apple, Microsoft is sitting on a lot of cash. Net of debt, Microsoft has about $72 billion in cash, bringing the enterprise value down to just about $200 billion. In fiscal 2013, which ended in June, net income came in just shy of $22 billion. At today's prices, an investor is paying just about 9 times earnings adjusted for cash, providing an ample margin of safety.

The future also looks bright for Microsoft. Its cloud services, like SkyDrive and Azure, are growing extremely fast. Products like SQL server and Windows server are also doing well, and an updated version of Windows 8 fixes many of the problems with the operating system. Office 365, the company's cloud-based subscription version of Office, is growing at a blistering pace, and Microsoft won back more than 400 enterprise customers from Google last quarter. Clearly, Microsoft's reign as the king of the enterprise space is not over.

Hertz: A low-tech bargain
The technology sector doesn't hold all the bargains, though. Rental car company Hertz recently got slammed for revising its guidance downward, with its shares falling by 16% in a single day. This was a classic overreaction, and Hertz now presents a real bargain to investors.

The guidance cut was due to weak demand for airport car rentals, which is Hertz's biggest business. Earnings-per-share guidance for the full year was cut by a dime, from $1.78-$1.88 to $1.68-$1.78. The new range still represents more than 30% growth year-over-year, so it's a bit baffling why the stock was abandoned by investors.

The stock currently trades at about 12.7 times the new high-end estimate, but the real value comes out when we look at the multi-year picture. Hertz has guided for EPS in 2015 of between $3.10-$3.30, and the company still expects to reach that goal. Hertz bought Dollar Thrifty earlier this year, and while this -- along with weak demand -- has led to short-term fleet utilization issues, cost savings and synergies should allow the company to continue to grow its bottom line at a relatively quick pace.

If the company reaches $3 per share by 2015, the stock could easily be worth $45 per share at that time, representing a 100% gain in a little more than two years. Even if the company misses a bit, the current price offers a significant margin of safety. Anywhere in the low $20s, Hertz is a bargain.

The bottom line
While there are fewer bargain opportunities today than there were a few years ago, there is still value to be had in this market. Often the best time to buy a stock is when sentiment has turned negative for illogical reasons, and all three companies listed above have recently faced exactly that.

Understand Apple before you invest
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Timothy Green owns shares of Microsoft and Hertz Global Holdings. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple, Hertz Global Holdings, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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