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By Jeremy Glaser and Grady Burkett, CFA | 01-28-2013 11:00 AM

Not the Time to Turn Off Tech Stocks

Although the tech sector hasn't had the best earnings season, Apple, Microsoft, and others still have solid long-term fundamentals and are trading at attractive discounts.

Jeremy Glaser: For Morningstar, I’m Jeremy Glaser. It's been an eventful tech earnings season so far, and I’m here today with Grady Burkett; he is our director of technology research. We're going to look at some companies that have reported so far and where the best values are today.

Grady, thanks for talking with me.

Grady Burkett: Thanks for having me, Jeremy.

Glaser: So, I think we have to start with Apple. Certainly that's been the big news story so far. The stock has sold off pretty substantially since [reporting its] earnings and even before then. We talked to our Apple analyst, Brian Colello, about some of these specifics, but what else have we seen at Apple? Does it portend a broader decline in tech names?

Burkett: I think a lot of what we're seeing with Apple is a function of expectations kind of coming in for that particular company. So I don't know that you can necessarily extrapolate a trend across the entire sector. I will say that we took our fair value estimate down on Apple on the results. And essentially what happened is we lowered our long-run revenue projections and our long-run gross margin projections just a bit, but that flows through to free cash flow pretty substantially.

So, with Apple right now, we're expecting free cash flows to be roughly flattish over the next five years. So, that's kind of the bogey for investors to think about with that particular name. For investors, I think that the one key takeaway from our projections in the current stock price is that the market price implies decline and pretty substantial decline, and we think that's very unlikely for a company with such durable competitive advantages. It's a very well-run company still. It still has growing markets, and so $450 per share, $440, we think it's a very attractive company to look at right now.

Glaser: One area of Apple's quarter that that was weak was PCs, the Mac business. Some of that was [the result of] supply chain issues, but there has also been a broader weakness in PCs. How did that play out in, say, the results of Intel and Microsoft this quarter?

Burkett: Yeah, and that was interesting also. I mean, we had Intel post a little bit of a disappointment. It's interesting after all the gyrations of the quarter, we're still at about $21 per share on that particular name. So, we're had a pretty strong runup in the shares going into the middle of the year. I think investors got overly excited about Windows 8 and some of that would drive Intel. I think investors were really excited about what was going in the x86 server business as well. And when we saw some of that excitement kind of deflate. Again it's a situation where expectations came up maybe a little bit too aggressively, and now we're back at a slight undervalue, about a 20% discount to fair value. So, again it's a name with the 4% dividend yield that we find attractive right now.

Looking forward with Intel, we continue to think that story is about the growth of the x86 server microprocessor market, and then how the firm navigates, how they move into mobile, and then how the PC market fluctuates over time. So, we think the PC market is flattish, maybe has very sluggish growth globally, but we think Intel can continue to grow that server microprocessor business. So, we do like Intel.

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