Friday, August 26, 2011

Oracle Predicts a Bright Future

Business software and hardware maker, Oracle (NASDAQ: ORCL) has had a pretty good run since in 1986 IPO -- its stock is up about 40,000% from the split-adjusted $0.08 it traded at back then. Does it still have further to run?

One thing's for sure -- investors are increasing their bets that Oracle stock is going to fall. How so? As of August 15, Oracle stock ranked fourth on the list of top 50 increases in short interest on NASDAQ from the previous two weeks. Specifically, short interest in Oracle stock is up 57% to 34.6 million shares from the period ending July 29.

In its second quarter, Oracle beat expectations. It reported 75 cents a share -- four cents ahead of expectations. But its revenues of $10.8 billion only met expectations and its hardware sales -- from its purchase of Sun Microsystems -- fell 6%. Although those sales make up only about 10% of its total revenues, Oracle stock fell 6% in after-hours trading on the earnings announcement.

Is the rise in Oracle short-interest related to expected bad news on hardware sales when it reports its third quarter results next month? Does this mean you should avoid the stock?

Here are three reasons to consider buying it:
  • Good quarterly earnings. Oracle has been able to surpass analysts’ expectations in all of its last five earnings reports.
  • Oracle is out-earning its cost of capital and it's improving. How so? It produced positive EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In 2011, Oracle's EVA momentum was 4%, based on 2010 revenue of $26.8 billion, and EVA that rose from $2 billion in 2010 to $3.1 billion in in 2011, using a 10% weighted average cost of capital.
  • Increasing sales and profits and strong balance sheet. Oracle has been increasing sales and profits. Its $35.6 billion in revenues have risen at an average rate of 18.6% over the last five years while its net income of $8.5 billion has increased at the same annual rate -- yielding a tremendous 24% net profit margin. It has no debt and its cash rose at a 23.3% annual rate from $7 billion (2007) to $16.2 billion (2011) to during the period.
One reason to hesitate is that Oracle is a fairly expensive stock. Oracle's price to earnings to growth of 1.38 (where a PEG of 1.0 is considered fairly priced) means it is fairly expensive. It currently has a P/E of 15.5 and is expected to grow earnings 11.2% to $2.58 in fiscal 2013.

My hunch is that there is a good reason that Oracle's short interest has spiked so much. Thus I would be inclined to wait until the shorts have taken their profits -- at which point Oracle stock will be lower -- before buying.


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