Innovation: A Look at "Old Tech"

Posted by Rob on July 12th, 2012 at 8:12am

Most people would agree that innovation is the key element for the sustainability of a technology company. As a result, I laugh to myself when I hear the term "old tech." To me, this term implies that these companies have failed to continually innovate in the present and are merely riding the wave of their past success. Is that possible as a technology company? "Old tech" companies that come to mind in this regard are Cisco (CSCO), Intel (INTC), and Microsoft (MSFT). Let's take a closer look.

Ten to twenty years ago, all three of these companies were dominant market players, and the fact is, they still are. However, there is a subtle difference; they are not innovative market players. To put it simply, INTC continues making chips, CSCO produces networking equipment, and MSFT generates operating systems. Sure, there are arguments for each company that innovation has occurred within their respective niches, but has it?

For example, MSFT's Windows 8 employs an interface based on its Metro design language (similar to its Windows phone) that is meant to accommodate both touchscreen and keyboard/mouse input. Each tile of this interface design represents an application. Sound familiar (AAPL)? Yes. Innovative? No. Even its latest hardware release, the tablet called Surface, is hardly innovative. A tablet with apps? Genius, but about three years late.

From an investor standpoint, all three of these "old tech" companies have largely disappointed shareholders. As one can see in the comparison chart below, these companies have resulted in little capital gain and even loss for long-term investors.

However, while these companies' best days of innovation are behind them, they are still very successful. In fact, their EPS growth is very strong. For example, MSFT's EPS was $0.68 in 2001 but is currently $2.75. So why hasn't the stock price appreciated with this increase in EPS? The reason is simple. These companies were the pinnacle of the dot-com bubble and boasted extremely high P/E ratios (over 40). In other words, the market had already priced in this growth over the last decade which gave the stocks little room to appreciate for longer term shareholders. All three companies' P/E ratios are currently between 10 and 12 and thus presently stand at a more attractive valuation.

While the over valuations of over a decade ago may have contributed to the disappointing return for shareholders, the ultimate performance measure of these companies returns to innovation. When comparing these "Big Three" to AAPL, who was founded one year after MSFT and is definitely not considered "old tech", AAPL is clearly the leader in technology innovation. With AAPL's market cap more than double MSFT, quadruple INTC, and sextuple CSCO, it clear that innovation is indeed the key element for not only sustainability but also high growth of a tech company.

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