A tech stock to own now
You may know this company for its stock that soared, then collapsed. It won't ascend like a rocket again, yet it should hold plenty of appeal for conservative investors.
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By Jon Markman
MSN Money
If you tweet or use Facebook, e-mail or instant messaging, you are to blame for creating the largest pile of permanent waste in the history of mankind. Nice going.
Never mind that your messages are ethereal wisps of digits and electrons and that 99% of them are useless a few seconds after they are created. They are 0s and 1s that will be stored on some disk drive somewhere whether you want them or not, ready to be retrieved by your grandkids, prosecutors and historians for all eternity.
A slew of companies have emerged in recent years to manage all of this digital excess, but one stands head and shoulders above the rest. And, amazingly, it is what investors call a "fallen angel," a once-great outfit that has fallen on hard times and yet has the capacity to rise again.
That company's shares may be the one stock that conservative investors need to own for the next few years, particularly those who are a little shy about the rapid recovery in share prices and the uncertainty of the global economy. Its value is already so bombed-out that everyone who wanted to sell it has fled, and now it's owned mostly by new investors who have taken a shine to its slightly scuffed appearance and are ready to dream again about how great it can be.
The company is data-storage specialist EMC (EMC, news, msgs), and I know it's going to be familiar to a lot of people, for good and for not-so-good reasons. Here's why it's so notorious, and why it is such a good bet now.
'90s nostalgia
During the 1990s, which I believe we are about to repeat, EMC shares put in one of the greatest advances in market history. The stock rose 65,450% from January 1990 to December 1999. Ten thousand dollars invested at the start of the decade was worth $6.5 million at the end, if you'd had the foresight and patience to keep it through booms and busts. Which, let's face it, would have been tough. I don't know about you, but every time I have a 10,000% gain, I feel like taking profits.
What happened next at EMC was not a unique story. Excessive optimism crept into entrepreneurs' animal instincts, so new competitors crowded into its space with lower-cost offerings, and the ensuing price war crushed its profit margins. EMC, which was always known to have one of the best sales forces on the planet to go with its great product offerings, managed to annihilate those latecomers with brusque dispatch, but the damage was done: Once the pricing genie is out of the bottle, it's almost impossible to stuff it back in.
So after that amazing decade, EMC shares began a breathtaking collapse. And now, the once-godlike stock has tripped on leaden feet to fall 80% since the start of this decade. At the stock's peak, expectations got so out of whack with reality that investors were willing to pay more than 100 times earnings -- a superhigh price-earnings multiple of 125. But in the multiyear collapse, those expectations dwindled into a pit of despair, until the P/E multiple hit 10 in February. It's now around 18, based on my estimate of next year's earnings.
That is very cheap for a company of this caliber with potential to grow 20%. You see, companies such as Procter & Gamble (PG, news, msgs) get a forward-looking P/E of 14, and the detergent maker is not going to grow much more than 5% next year, if that much.
EMC may be tarnished, but it has already begun to sparkle a little bit in a few corners. What will make it worth your hard-earned dollars over the next few years?
Expectations are still fairly low, which is always the key to future success in the market. Most analysts expect the company to earn 84 cents a share next year, which would amount to fantastic 32% growth over 2009. But I actually think that's too low coming out of a very low base and that the company has a very good shot at earning $1.10 a share next year.
Growing again, steadily
Here's why EMC will grow: All indications from the marketplace suggest the company enjoyed a very solid September with its elite roster of Fortune 100 customers with stiff data-storage needs, which will allow it to report better-than-expected results Oct. 22. And reports from the field also suggest that the current quarter has already started off with a bang, as customers are finally loosening budgets that were severely tightened during the recession and replacing old equipment with the technology that will permit improved retrieval of every work, play and medical twitch of your increasingly digital lives.
That's the long-term picture. Short-term results will be driven by better gross margins (net income before taxes) due to manufacturing efficiencies and a lower cost structure in the wake of head-count reduction of 7%, around 2,400 EMC workers. Analysts estimate that every 1% reduction in operating expenses results in 2 cents per share to the bottom line.
Both of these elements are important, but the biggest boost will come from better sales, because a company like this needs to keep innovating and creating more reasons for customers to pick up the phone and buy its equipment.
EMC has used the recent fallow period to become the leader in a niche called network-attached storage, which was just a small part of its business five years ago. It has since muscled its way past smaller rivals to become the top vendor, with 36% market share -- about 5 percentage points more than its top competitor, according to calculations from analysts at Broadpoint AmTech.
The majority of its revenue in the storage-area-network space comes from its high-end Symmetrix line, which provides companies with faster access to data because it utilizes solid-state drives with an industry-leading reliability promise of 99.999% -- known as the five nines standard.
And, finally, EMC has retained a large stake in VMware (VMW, news, msgs), a spun-off unit that sells the hottest infrastructure enhancement going for companies trying to save money today: virtualization software. Because most computer servers at companies normally run at a lousy utilization rate of 15%, this software allows them to get more computing power for less money -- the key selling point. VMware is virtually the only company that Fortune 100 companies use for this service, and EMC owns 83% of it.
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Skeptics will say that EMC has seen its best days and that growth will be modest going forward -- and I don't disagree. This is not going to be one of those stocks that rockets 100% a year over the next couple of years, like some of the recommendations I made earlier in the spring and summer.
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But we're talking about one tech company that can still grow 15% to 20% a year and has the potential to see its price-earnings multiple expand by 5% a year because the need for storage is the only thing in technology that is truly growing exponentially. And that's thanks to all those tweets, Facebook posts, e-mails and instant messages that I mentioned a moment ago -- not to mention the Obama administration's lust to put all medical records in a digital format in the next half-decade.
Figure that EMC, now trading around $18 a share, can get back to about $35 over the next three years with any kind of tailwind from the improving global economy, back to where it traded in 2001. Its rivals IBM (IBM, news, msgs) and Hewlett-Packard (HPQ, news, msgs) have already made that journey, and as long as you keep creating data, it'll keep creating profits.
Fine print
Check out EMC's products and services here and here. Learn more about Broadpoint AmTech here. Learn about virtualization software here. . . . It's great to see the casinos charge back after their weak spring. On May 14, I recommended Las Vegas Sands (LVS, news, msgs) and Multimedia Games (MGAM, news, msgs) around $8 and $2.75, respectively. (See "In an economic desert, signs of life.") They closed Friday at $18.05 and $5.02. . . . For more ideas like this as the market rally progresses, check out my daily newsletter, Strategic Advantage (membership required).
At the time of publication, Jon Markman owned shares of the following company mentioned in this column: Hewlett-Packard.
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