There is never a shortage of technology companies out there, but there are very few truly genuine technology companies. Instead, almost all of the companies people call "tech stocks" are really companies that use technologies to make or to sell their products. They have no real technological advantage whatsoever. As a result, it's difficult for them to achieve the advantage of scale that is the hallmark of great tech companies.
The secret sauce of great tech- companies
I believe that a great tech company should have a great moat surrounding its business. Of course, there will always be competition, but with a strong moat a tech company is bound to survive and even prosper from the untimely death (or bankruptcy) of its rivals. Not only that, but a great tech company will always keep its shareholders content by rewarding them with dividends and aggressive share buy backs.
Which is a better tech- company?
Using the two parameters set out above, I will compare two very different companies: Intel and Apple ,
Quality #1: Nature of technology moat
Intel takes sand (silicon) and applies decades of research and engineering to turn it into the heart of the modern world – computer chips. The moat around its business is both high-tech expertise and intellectual property. It is difficult (impossible, really) to compete against Intel in the microprocessor market, where it has tremendous scale.
That's because most of Intel's costs are fixed. It has been investing billions of dollars in building state of the art plants, creating innovative technological processes and hiring brilliant engineers. But it doesn't cost much at all to make each chip. This lack of marginal costs is what makes Intel so unique.
Apple, on the other hand, has almost no moat. True, its brand name is unique, but it isn't indispensable. People might change their preferences and tastes overnight. You can ask Nokia about it, they'll be more than glad to elaborate on this topic. As more and more rivals enter the ring, Apple is forced to cut the price of its products and sacrifice part of its profit margins.
I understand that it's almost inconceivable to think of Apple as the next possible Nokia, but it isn't that far fetched. Nokia, once a $100 billion company, now trades for a paltry eighth of that sum. It's trading for a price/sales of only 0.3x not because it's a value gem but because it's losing more and more cash with every passing quarter. And remember that Nokia was the coolest company around. Its phones were sharp, cute, and endorsed by many. But that didn't help the company a bit when consumers decided to desert hardware and shift their preference towards software and 'touch'-capabilities.
Quality #2: Shareholder- oriented company
Last year, Intel earned more than $20 billion in cash. With this huge profit, Intel spent more than $16 billion returning capital to its owners via cash dividends ($4 billion) and share buybacks ($12 billion). In short, shareholders at Intel kept 80% of the profits. Since Intel is a $100 billion company, this translates into a shareholder yield (cash + share buybacks, divided by market cap) of 16%. That's extremely impressive.
Apple, on the other hand, is a totally different story. The company earned $50 billion in cash last year. How much of those vast riches did its shareholders get? Almost nothing – $4.5 billion in total dividends (cash and net share buybacks). The company kept more than 90% of its earnings. I believe that Apple understands its business vulnerability very well, which is why it keeps such a massive cash cushion of more than $150 billion (and counting).
The Fool thinks tech, the right way
Apple is much more liked than Intel by Wall Street, but this may change very quickly. I believe that due to its massive technological moat and shareholder friendliness, Intel is a much better bet than Apple down the road.
Copyright © 2009 The Motley Fool, LLC. All rights reserved.
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