In contrast the tone of some optimistic technology companies, Dell (DELL) reported on Thursday evening that the bottom in sales of computers could still be ahead.  Recently, Intel’s (INTC) CEO said he was confident that the worst was behind them (Chip Makers in Focus), and he may be right but Dell is not ready to make that sort of claim.  Signals are mixed as to what the demand outlook will be for the rest of the year, but the company did allude to what they believe will be a powerful replacement cycle.  There was no time frame attached to this statement, but it does make since that after a period of slower sales that there will be good sales growth when the business cycle turns.

The quarterly performance was again pretty weak for Dell, although better than analysts had anticipated.  The company earned 23 cents per share in the quarter a penny better than expected, even though it represents a 63% drop from a year ago.  Revenue did not reach the analysts estimates, which shows that Dell has been quite effective in cutting costs through the downturn to be able to keep earnings up.  Interestingly, according to Yahoo! finance (YHOO) analysts have been lowering EPS estimates for Dell in the last thirty days by a ratio of 4 to 1.  With the general improvement in the stock market over the last two and a half months, that is a bit of a surprise.  Dell’s stock is up about 3% in Friday morning trading as the company beat the lowered earnings estimates and refrained from given formal guidance.

Dell continues to be Undervalued by our methodology, as it has been for quite some time now.  A quick glance at some of Dell’s valuation metrics gives a good indication of why, for example, price-to-cash has historically ranged between 14.9x and 25.7 over the last ten years and the current metric is well below this level at just under 7.  Similarly, price-to-sales currently sits at just about one-third of the low end of the historically normal range.  Even with profit margins that are traditionally very low, Dell management still has a track record of producing ROE that is quite impressive.  The company has an immense cash hoard and in comparison very little in the way of debt.  We are continuing to reaffirm our positive outlook on a long term valuation of Dell.

“Dell reporting sharply low earnings on falling pc sales saying it is not ready to call bottom just yet. Sales of laptops falling 20% due to weaker demand sending profit down 63%. On the bottom line Dell earns 24 cents per share that is a penny better than the estimate. This morning Barclays raising Dell’s price target to 10 bucks a share that’s up a buck but less than where the stock is trade right now. Deutsche Bank raising its target on Dell to $15 per share.” Fox Business Money For Breakfast 5/29/2009

Jim Cramer is talking about technology more than any other sector these days.  Last week, he profiled one tech stock per day that is not traditionally talked about.  Well, he continues to believe that tech is leading the market.  According to Cramer, the downturn in tech was one of the reasons that the market’s decline was so severe and the market’s rebound has largely been due to the leadership of the tech sector.

“We were in the grips of a particularly heinous downturn — a downturn that all started with tech. The whole sector from Apple to Yahoo!, that had rocked our the group that had provided the best leadership in the market. Hallelujah!” CNBC’s Mad Money 5/14/2009

Cramer has an unconventional take on the past year, as most people would have pointed to the financial sector and credit markets as the sector most at fault for the market’s declines.  Either way, he is trying to point out that normally the sector that leads the downward is also the one that will be the quickest to recover.  He believes that the lows have been set and the bull market has begun, even if caution is still warranted.  That is why he is loving some tech stocks right now, such as his four hoursmen: Apple (AAPL), Research in Motion (RIMM), Google (GOOG), and Amazon (AMZN).  In addition, he specifically pointed to  AMD (AMD), Intel (INTC), VMWare (VMW), and Salesforce.com (CRM) as other tech names that he is keeping an eye on.

The chart to the right shows all of the stocks mentioned on last night’s Mad Money, and notice the particularly heavy emphasis on technology.

“Some love stories are eternal, Romeo and Juliet, Luke and Laura, and now Microsoft and Yahoo!. How else do you describe it? Like a lover’s quarrel going on between the companies. Microsoft CEO Steve Ballmer keeping the door open between the marriage between the companies. The dream that lives on…Keep in mind, while a deal seems economically attractive, they have not sat down formally as Ballmer is waiting for a time that seems more appropriate. He’s waiting for Carol Bartz, the new CEO of Yahoo!, to get settled in, in her new position…Jonathan Miller, former guy who ran AOL…expects consolidation going on this year saying, ‘I don’t know how anyone competes with Google on their own.’ it’s not just about love, it’s about being competitive and the door is open again.”

This clip was a part of the Fox Business Network’s afternoon coverage.  Of course, no one believes that there really is any sort of affinity between Microsoft (MSFT) and Yahoo! (YHOO).  Although, the constant rumors and breakups do sort of remind you of a middle school romance.  However, what they do have is a common enemy, in terms of search, in the clear market share leader Google (GOOG). In recent studies of market share Google has more than 70% of the market and Yahoo! is a distant second at 19%, according to Compete.com.  Microsoft’s offering, MSN/Live is tiny in comparison at under 7% of total market share.  Clearly, if these two smaller search competitors want to get their piece of the lucrative search advertising market they will likely need to merge.  Online ad sales are suffering in the recession, but not nearly to the extent of the slump in print and television ad sales.  Everyone is well aware that, online ads will be a huge part of the advertising picture going forward into the future as well.

At this point, Microsoft and Yahoo! are pretty much one-trick-ponies; Microsoft with the operating system and Yahoo as a web portal.  Microsoft needs to figure out a winning strategy in an increasingly web based word, perhaps Yahoo! has the answers.  For the two to join forces could potentially make a lot of sense, but a deal is not imminent.  Ballmer has stated that he wants to give Bartz time to get her bearings before formally talking.  After all, we have been down this road before with much of the negotiating going on beyond the negotiating table in the press.  The fumbling of the first attempt by Microsoft is part of the reason that Bartz was brought on to replace Jerry Yang as the company’s head.  Bartz has made it clear, were talks to formally resume she wants them to be held more closely to the vest to avoid the media circus.  Microsoft’s first attempt at takeover of Yahoo! was for a total of nearly $45 billion, now more than a year later the company’s market cap is less than half of that.  If I were Steve Ballmer, I wouldn’t necessarily rush into anything either.  Microsoft might be better served to see how things play out in the economy rather than jump into something without all the information.

A study of online advertising was recently released by the Interactive Advertising Bureau and PricewaterhouseCoopers. What it revealed is that internet advertising is growing despite the economic downturn. Total online advertising revenue for the third quarter neared $5.9 billion. That’s an 11% improvement from last year’s third quarter and a slight 2% gain from the previous quarter. The study also concluded that year-to-date web advertising has brought in $17.3 billion, which is an improvement from $15.2 billion through three quarters in 2007. This study should not be considered the final authority on interactive advertising, but it does demonstrate an apparent resilience in the face of economic hardship.

The study is welcome news to Google (GOOG) which has seen its stock fall by 60% so far this year. Apart from the generally negative momentum of the stock market, Google’s stock has suffered from the expectation that its search-engine-based advertising would suffer as companies strip their marketing budgets. Advertising has been curtailed significantly as many retailers are struggling and the automakers are just trying to stay in business. However, the brunt of the pull-back has been felt in more traditional media like television and print. Growth in what is termed interactive advertising has not suffered nearly as badly. One potential reason is that with the interactive advertising results are more easily quantifiable because mouse clicks are tracked. By tracking where eye-balls are looking, advertisers can know what is working and what is not, which is of course very valuable.

When it comes to bringing traffic to your interactive ad, there is no better company to work with than Google. Internet searching continues to grow, as we mentioned in our October 1^st piece (Just Google It).  A Pew internet usage study found that now half of all internet users surveyed use a search engine at least one a day. Only one-third did in 2002. What has happened in the meantime? Oh that’s right, Google happened. Of course, I am only kidding, but Google’s dominance in search traffic is astounding. Month after month Google generates around 70% of web queries. Google has hit the “sweet spot” of having incredible proprietary search technology, a single and clean layout, and loads of open source programs and widgets for an ever growing internet audience. The company is suffocating its weaker search competition such as Yahoo! (YHOO) and Microsoft (MSFT). These factors all enable Google to attract internet users from beginner to expert to its site as well as offshoots. However, as its stock price swoons, Google has begun to monetize it’s formerly ad-free Google Finance site.

Our readers will remember that we believed that GOOG was Undervalued at around $400 and now that the price is down more than 30% to $275, we have GOOG rated Greatly Undervalued. The markets are fearful but by our indications Google is doing the right things as both revenues and earnings continue to grow. Sales growth for 2008 is estimated to be 36% and earnings for the year are expected to be up 25%. That assumes that 4^th quarter results are in line, and they probably won’t stray too much from these estimates.

Google has been strengthening its fundamentals but its stock continues to slide, so by any historical valuation method, Google is very cheap. Price-to-sales has historically ranged between 7.17x and 14.3x, but the current price-to-sales is a meager 4.66x. Similarly, the historically normal price-to-cash flow range is 24.2x to 48.99x, but the current price-to-sales is just 15.12x. For Google to return to just the low end of these fundamental valuation ranges, we would expect to see the price in the upper $400’s. Some would say that we are overly optimistic, but Google has continued to thrive during a tough environment and we expect them to remain the top search engine and internet advertising business into the foreseeable future. Consider the words of Piper Jaffray’s esteemed technology analyst Gene Munster as he endorses Google (he has a buy rating and a $600 price target on GOOG):

“Google continues to be far and away the best company in the Internet space and operates in an advertising vertical (direct response) that historically fares well in an economic downturn. We believe this combination makes Google the top Internet stock to own in the current economic tumult.”

Yesterday afternoon was an odd one for Google, Inc. (GOOG) stock and an embarrassing moment for the NASDAQ Exchange. We noted right away—as I am sure many in the investing community did—that GOOG was tanking right before the close. Around the office people began to wonder about hedge funds or other institutional investors liquidating their positions at the quarter end. We speculated that value investors would be drooling over Google at the quoted prices; depending on the source you trust, GOOG actually got down to $25.80 (CNN Money) or even one penny (Reuters)!

As it turns out, it was all much ado about nothing. It was a major glitch, as a spokeswoman for NASDAQ (NDAQ)explained, “A market participant sent in a large number of orders and drove the price down at approximately [3:57p.m. ET] which caused the bid-offer to be artificially low due to their mistake.” It’s funny that an exchange which is exclusively electronic would blame a participant for the mistake instead of the entity that allowed the trade to occur. Anyway, the erroneous trades are being wiped out and NASDAQ set the closing price of GOOG for September 30, 2008 at $400.52, slightly above where it began the day. Aren’t computers supposed to make market trading more efficient?

Back to reality, GOOG shares in the low $400 are too cheap to ignore according to our methodology. We, at Ockham Research, are huge fans of Google’s products which are indispensable to our daily workflow. Google is one of those iconic brands whose name has become a part of speech. One does not search the web anymore; it’s simply referred to as “googling”. Other brand names that come to mind which have entered the lexicon of business are Xerox and Tivo.

Google is now so much more than a search engine. The company is constantly expanding into new territory, such as: its new web browser Chrome, the Android platform for its G1 phone and even a partnership to explore alternative energy with General Electric (GE). We do not know whether these products will eventually become dominant market players, but they are interesting prospects. We wish Google all the best—especially in finding cheap and clean energy sources—but as an investor, we prefer to ponder observable successes, such as that which GOOG has enjoyed with its search engine. Internet users are searching the web more than ever. A Pew internet usage report from 2002 showed that only 33% of internet users utilized a search engine daily; in 2008, that number is almost 49%. That is half of every internet user every single day! Google is gaining market share in search engine usage as well. On many months, Google gets a dominant70% of all searches versus competitors Yahoo (YHOO) and Microsoft (MSFT). This equates to more revenue via its core business of internet advertising.

In terms of valuation, $400 per share may sound pricey but it clearly is not based on historical valuation ranges. GOOG has fallen rather rapidly during 2008 from its high of nearly $750 in November 2007. That’s a drop of 46%, yet its revenues continue to grow. Furthermore, on a Price-to-Sales basis, GOOG has normally traded between 8.65x - 16.1x in its short history. However, the current Price-to-Sales metric looks cheap in comparison at 6.9x. Similarly, Price-to-Cash Flow, which is currently 22.2x, has historically ranged from 29.4x - 55.8x. Being a value shop, we rarely find such great growth stories this undervalued. We have awarded GOOG an Undervalued rating as it has been over-sold in this market and we think it is reasonable to expect GOOG to rebound into the mid $500’s going forward.