“On Thursday, after the close, Intel reported a super-duper “I love you, you love me” total blowout. They outpaced The Street’s consensus earnings by ten cents on strong sales …When the company blows numbers out like Intel you want to throw up your hands…Intel is selling more chips and getting more money for them. As the average selling price for microprocessors was up, even as PC pricing is coming down…

The bottom line, Intel may have sold off the day after reporting the fabulous fourth quarter but the pull-back was because the stock was ahead of itself.”– CNBC’s Mad Money 1/19/2010

Intel Corp. (INTC) delivered a tremendous fiscal fourth quarter last week, but the stock gapped down nearly 3% on the following day and has yet to recover.  This head-scratcher of a situation has CNBC’s star pundit Jim Cramer felling bullish on Intel, and he even said that he’s increasing his exposure to Intel in his Charitable Trust if it falls below $20.  We can understand why he is bullish on Intel upon completing a great second half to 2009, and the turnaround in technology spending (just as Intel’s CEO predicted last September) is being solidified through results from other technology bellwethers like IBM (IBM).

Intel’s lack of appreciation after a great quarter has led to a frenzy of analysts increasing earnings targets over the past week.  According to Yahoo finance, 36 out of a total of 45 analysts following the stock have increased their predictions for 2010 EPS and lifted the consensus from $1.64 to $1.79 in just a week’s time!  Despite the improved performance for Intel over the last two quarters and the improved outlook for 2010, the stock has actually substantially underperformed the rest of the Technology sector over the last six months as measured by the iShare (IYW).  Intel has returned about 10.5% compared to the sector performance of over 20%.

At Ockham, our valuation methodology rates this stock as Fairly Valued.  One criterion in our analysis is a look at current price-to-sales metrics compared against historically normal ranges.  Over the last ten years the market has been willing to pay between 3.1x and 5.6x sales per share, and the current multiple is on the low end of that range at 3.3x.  Similar historical studies of price-to-cash earnings, historical ROE, etc show a similar story: Intel is neither overvalued nor particularly undervalued.  Judging by the way the market has traditionally valued Intel shares and comparing that with current fundamentals, we think a price between $19 and $26 would be in line with historically normal valuations over the past ten years.  However, the fourth quarter demonstrates Intel is really hitting its stride right now, and may finally begin to command a better valuation in the marketplace shortly.

“We just gave you the numbers on IBM. Big Blue $3.59 per share versus estimates of $3.47. Revenue came in at $27.2 billion versus $27 billion.” — CNBC’s The Closing Bell 1/19/2010

Investors were bullish on International Business Machines (IBM) coming into their quarterly report on Tuesday afternoon, as stock finished near its all-time high price above $134 per share.  And why not?  Management at IBM seems to have this game figured out, and has the company pointed in the right direction on practically all fronts.  The optimistic tone of the market heading into the close reflects bullish whispers on the trading floor for the world’s largest computer services company.  A company like IBM carries a lot of weight for the rest of the technology sector, and any earnings surprise would help to confirm an ongoing recovery in corporate IT spending.

The confidence in Big Blue was not misplaced as the company came out with better than expected results for the fourth quarter.  IBM earned $3.59 or twelve cents better than the consensus analysts’ estimate, and the results even topped the most bullish analyst by a penny.  In addition, investors want to see top line growth in these reports as the estimates were for 4Q09 revenue to be flat, but it did in fact grow about 1%.  Gross margin improved to 48.3%, continuing its impressive record of growing margins in 21 of the last 22 quarters.  Furthermore, service signings were very strong rising 9% to $18.8 billion bringing the estimated services backlog to $137 billion.

For the year, IBM booked record net income of $13.4 billion, and had its seventh straight year of double-digit EPS growth.  Diluted EPS grew 13% to $10.01 per year, and free cash flow topped $15.1 billion, again, a record for the firm.  For the year ahead, IBM looks to continue its strong performance and double digit earnings growth and now forecasts a minimum EPS of $11 per share, which is slightly higher than expectations.

As you can tell, IBM is taking full advantage of the turnaround in technology and services spending and continues to raise the bar for itself.  Interestingly, as of this week’s report we downgraded IBM to Fairly Valued rating from Undervalued because the company’s success is being adequately recognized by the market.  Based on current fundamentals, we think IBM should trade for between $121 and $152, so at a price in the mid $130s IBM is not cheap.  For example, over the past ten years the market has been willing to pay 1.42x to 2.14x revenue per share for IBM.  The current price-to-sales metric sits comfortably in that range at 1.83x, and it is a similar story when it comes to price-to-cash earnings metrics.

IBM’s fourth quarter demonstrates that the company is performing quite well, and that could be a great thing for the technology sector going forward.  Big Blue is managing impressive earnings growth and margin expansion and they deserve credit for that.  That being said, IBM’s story is well known to the market and it is no longer a great buy at these price levels.  We would advise investors to look to some of the lesser known success stories in the tech sector to take advantage of this trend.

“Last night, Emulex had some comments…A storage network company see EPS up around 16 to 17 cents. Previous guidance, top of that range 12 cents…” — The Opening Bell on Fox Business 1/12/2010

Makers of storage networking equipment, Emulex Corp. (ELX) said that they are having a better fiscal second quarter than analysts had expected.  In fact, the new earnings guidance of 16 or 17 cents per share is well above their previous guidance of 10 to 12 cents per share.  Furthermore, revenue is now expected to be about $107 million compared to previous estimates of about $90 million.  The great performance was driven by strong demand for its products which connect computers and servers to remote storage services.  Many of the world’s largest makers of servers, networks, and other technologies such as IBM (IBM), Cisco (CSCO) and Hewlett Packard (HPQ) are using Emulex technology within their hardware already.  Clearly, Emulex has an impressive list of clients already and hopes to add OEM relationships.

Emulex gained momentum in the second half of last year, and CEO Jim McCluney went on record as saying a recovery in tech spending was underway.  Apparently that momentum is still going strong in the New Year, the company’s Host Server Product has seen sales gain 28% and accounts for three quarters of revenue.  The Embedded Storage Product generates the bulk of the remaining sales and has seen growth of 20% in the last year.  Fibre Channel over Ethernet business is growing very rapidly (50% growth sequentially), but it is still a very small component of the overall sales total although the potential for this growing field is enticing.

Emulex is trading 11% higher after Monday afternoon’s preliminary release, and it has already prompted one analyst to upgrade the stock.  Overall, the analyst community has a favorable view of ELX as it has received four upgrades and no downgrades dating back to last summer.  The success of this company is highly dependent on corporate IT spending and many expect 2010 as a much improved year over 2009 where companies were very reluctant to spend on IT upgrades.  This pent up demand for stronger, faster servers and more robust storage equipment could provide for a very nice year for Emulex.

We are reaffirming our Undervalued stance on ELX as of this week’s report.  It is evident that the company was eager to give the market a glance into what appears to have been a very good second quarter, especially considering the weak performance of the fiscal first quarter.  Full details on the quarter will be made available on the scheduled reporting date of January 21st.  The stock has touched its 52-week high today of $12.77, but we are not yet concerned about valuation.  For example, over the past ten years ELX has traded for a price to sales ratio of 2.44x to 6.94x, and the current metric appears undervalued at 1.58x.  That is looking at the past four reported quarters and does not yet incorporate the latest quarter.  According to our methodology, we believe the stock would be fairly valued even at $15.50, so Emulex still has upside if they can keep the momentum.

We want a stock like Itron. The dominant player in smart grid; which is the smart grid transformation. When some huge, moldy company talks about how great the smart grid is like GE did Friday and IBM did on Thursday, you go take a look at Itron, because it can actually move the needle for this stock. Smart meters have been the easiest change to get regulatory help to achieve quantifiable energy savings. Smart meters remotely connect to you and read your power meter…

Itron’s the best way to play it. I was wrong on it before. I recommended it back on April 22nd of 2008 at $100. It was a green week play. I got that wrong because it’s down over 43%. We were caught up. We made a mistake. But now that the Obama Administration’s pushing for the timing on this one’s going to be just right…

…Whereas GE is a $170 billion company with its hands in just about everything, Itron is a $2 billion company that is all about smart meters. Which means the smart grid really moves the needle for this stock. Itron has a huge customer base with advanced metering infrastructure, smart meters and advanced meters reading. Slightly less smart readers that still require people to go out in the field and collect deployments to more than 8,000 utility customers in 130 different countries in around the world, companies that have some major smart wins.

…How about a $260 million contract with San Diego Gas and Elec for 2.3 million electric and gas meters running from 2009 through 2011? Itron has broad geographic exposure. 60% to 70% of its sales come from outside the U.S. that means it’s also a big beneficiary of the weak dollar. Itron trades at only 14 times 2011 earnings. I think it’s pretty reasonable given the stock’s projected growth rate of 26% from 2010 to 2011. Thomas Weisel just downgraded Itron based on the valuation, they think the stock’s run up too much. But it’s still down 11% year to date, I think it has room to run given it’s the top player in a that’s still in its early stages. When a big multi-business company like GE says positive things about a major theme like the smart grid on its conference call we step back, find a pure play Itron. Smart grid doesn’t just move the needle for Itron. It is the needle.”– CNBC’s Mad Money 10/19/2009

On Monday, Cramer talked about an emerging theme that he has noticed in the conference calls of such blue chips as General Electric (GE) and IBM (IBM).  Many companies are starting to come around to the idea of smart grid technologies as a way to help use energy more efficiently.  Cramer’s view on the situation is that these conference calls are informative, but there is a much better way to play the smart grid than GE or the like because they are already so involved in other businesses.  If you are interested in investing in smart meters and smart grids, the pure play is Itron (ITRI).

Cramer likes Itron for a number of reasons among them is the projected growth rate over the next two years, potentially benefiting from a push in green technology from the Obama Administration.  Furthermore, this stock is a weak dollar play with the majority of sales coming from overseas.  He also thinks the stock has room to run as ITRI has underperformed the S&P 500 by a significant amount year to date.

As for Ockham’s perspective, we are not quite as bullish and have the stock currently rated Fairly Valued.  This company currently trades within the historical valuation ranges of price-to-cash earnings and price-to-sales.  The growth in the use of smart meters and in general smart grid technology is exciting, but the company is already receiving a significant premium for expected growth.  Cramer points to the fact that Itron trades at 14x expected 2011 earnings, but that assumes impressive earnings growth.  The estimates Cramer uses are assuming a doubling in earnings by the close of fiscal 2011 which is only about 15 months away.  We are not saying that earnings will not improve from here on, but this is a growth premium that requires conviction to buy into.  For now, we are satisfied with a neutral stance on the shares unless they fall below $50.

Yesterday, we speculated that perhaps Dell (DELL) had awarded Perot Systems (PER) with too hefty a valuation given shrinking revenue and its dependence on healthcare and government contracts (Did Dell Overpay for Perot Systems).  CNBC’s Jim Cramer is in agreement with our assessment and this poor execution of an acquisition has landed Dell in the Sell Block.

The most obvious basis for comparison would be the tie-up of Hewlett-Packard (HPQ) and EDS.  In this deal, HP bought one of the biggest players in IT services for about $13 billion, and in so doing has successfully diversified itself away from hardware such as laptops, printers, etc.  Furthermore, HP is now more geographically diversified with about 62% of sales coming from outside of the US.  Now, HP could actually be considered a weak dollar play.

Meanwhile, Dell dragged its feet and is now left in a position of weakness and playing catch up with HPQ and IBM (IBM).  Cramer wondered why management was not more imaginative to buy someone like Palm (PALM) which fits his mobile internet tsunami investment theme.  Instead, they paid a greater valuation for Perot than was achieved prior to the technology bubble for a now shrinking company, furthermore Perot will not allow them to greatly diversify away from hardware in the short term (should claim about 85% of revenue).

The deal has left Cramer with a bad taste in his mouth, and he is bullish on HPQ and bearish on Dell going forward.  At Ockham, although we agree with Cramer’s take on the deal, our valuation methodology sees Dell as Undervalued at the current price.  As for Hewlett-Packard, the company has advanced steadily about 75% since hitting its 52-week lows.  So, although the company is strong fundamentally, the price has risen to the point that we would consider it Fairly Valued.