Oracle Corporation (NASDAQ:ORCL) recently reported the results from its most recent fiscal quarter, which ended in February and is the third quarter of the company’s fiscal year. Business was about flat compared to the same period in the previous fiscal year, with little change in either revenue or earnings. This was due to growth in software being offset by declines in a double-digit percentage decline in hardware (which is a significantly smaller portion of Oracle’s business). Many technology companies have seen a similar pattern in hardware vs. software in recent quarters, and so it is positive to see Oracle handling the transition. In the first half of its fiscal year Oracle was able to increase its net income but total revenue figures were unchanged and with this quarter’s results in we don’t think we would want to assume much earnings growth in the near future.
As a result growth in EPS seems to be driven by share repurchases. Earnings per share grew modestly last quarter form a year earlier, despite no change in the bottom line, as share count decreased 5%. With the stock trading at 15 times trailing earnings, however, we would still prefer to see net income improving rather than EPS growing solely through buybacks. In the most recent quarter, essentially all of cash flow from operations was consumed by share repurchases and paying Oracle Corporation’s small dividend.
Part of our work involves tracking 13F filings from hedge funds and other notable investors. We use our database of filings to develop investment strategies (we have found, for example, that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year) but can also use it to see which top managers like Oracle Corporation. At the end of December, billionaire Ken Fisher’s Fisher Asset Management reported a position of almost 20 million shares, making the stock one of its five largest single-stock holdings by market value (see Fisher’s stock picks). The Baupost Group, a hedge fund managed by value investor Seth Klarman, cut its stake by 23% during the fourth quarter but still owned over 10 million shares (find Klarman’s favorite stocks).
Other companies providing enterprise software and services include International Business Machines Corp. (NYSE:IBM) and SAP AG (NYSE:SAP). IBM’s business is in a similar financial position to Oracle’s: the trailing P/E is 15 and in the fourth quarter of 2012 the company turned in a 6% increase in earnings versus a year earlier based entirely on improved margins. As with Oracle, we think the stock may be a bit too expensive as of now given current growth rates. SAP is priced more for growth with both trailing and forward P/Es of 20 or higher, and to that company’s credit its sales have been up nicely. However, in its most recent quarter earnings actually slipped a bit compared to the same period in the previous year. It’s possible that the setback is temporary, but we still think we would avoid it at this time.
We look at Oracle against two other peers:
We can also compare Oracle to Microsoft Corporation (NASDAQ:MSFT) and to Workday Inc (NYSE:WDAY), which is a $10 billion market cap cloud computing application software company. Microsoft trades at 9 times consensus earnings for the fiscal year ending in June 2014, but while that does represent value levels we would be concerned that there would be a temporary bump in earnings that year due to sales of new versions of Windows and Office. A potential value thesis would have to try to normalize the company’s earnings over a longer time frame, though income investors might like Microsoft’s dividend yield of over 3%. Workday IPO’d in October, and is up 26% from its levels shortly after that time; the sell-side does not expect it to be profitable either this year or next year, and while it has beaten expectations in the two quarters it has been public we would worry that the “cloud computing” factor may have generated too much excitement about the company.
Oracle and IBM’s valuations are low enough to get our attention, but at least at this point neither company is growing its earnings enough that we would consider it a true value stock. They might be better placed on a watch list to see how business develops in the next quarter or two- particularly Oracle, which could supplement bottom-line improvements with share buybacks.
Disclosure: I own no shares of any stocks mentioned in this article.
