A significant portion of all the great advantages that the world has received through the promise of technology can be credited to the Big 3: Cisco Systems Inc. (CSCO), Intel Corp. (INTC) and Microsoft (MSFT).

Great gratitude should be attributed to these technology titans, because, thanks to them, the world enjoys a functioning Internet and enormous productivity advances.

[ad#Google Adsense 336×280-IA]Once powerful growth stocks, they have all morphed into solid dividend growth investments.

Today, an equal investment in all three would provide an above-average dividend yield of 3.37% with the potential for double-digit growth.

However, our bipolar business associate, Mr. Market, who for so long lavished ludicrously high valuations upon them, currently values them as though with disdain.

To me there is a great absurdity in it all, where Mr. Market just can’t seem to get valuation correct on the best of our blue-chip tech. However, we should always keep in mind one of the important lessons that Ben Graham attempted to teach us all. Ben Graham said, and I paraphrase, that investors are neither right nor wrong because others agree or disagree with them, they are right because their facts and analysis are right. Ben Graham crystallized this message with his famous Mr. Market metaphor courtesy of Wikipedia as follows:

“Graham’s favorite allegory is that of Mr. Market a fellow who turns up every day at the stock holder’s door offering to buy or sell his shares at a different price. Usually, the price quoted by Mr. Market seems plausible, but occasionally it is ridiculous. The investor is free to either agree with his quoted price and trade with him, or to ignore him completely.

Mr. Market doesn’t mind this, and will be back the following day to quote another price. The point is that the investor should not regard the whims of Mr. Market as determining the value of the shares that the investor owns. He should profit from market folly rather than participate in it. The investor is best off concentrating on the real life performance of his companies and receiving dividends, rather than being too concerned with Mr. Market’s often irrational behavior.”

What follows is a fundamental look indicating a trifecta bet on the blue-chip technology titans, Cisco, Microsoft and Intel. Simply stated, I believe the fundamentals indicate that all three are undervalued and therefore, offer a margin of safety, above-average capital appreciation potential with the sweet icing of an above-average and growing dividend yield.

For many years, investors were willing to buy these technology stalwarts high only to sell them low later. In contrast, I believe the following F.A.S.T. Graphs™, the fundamentals analyzer software tool, provide striking evidence that the reverse is currently true. Currently, I believe that these technology stalwarts can now be bought low with the opportunity to sell high later, with the added benefits of above-average income and a margin of safety.

Cisco Systems Inc.

Cisco Systems has generated operating earnings growth of 12.7% per annum since 1999. However, as previously stated, ludicrous overvaluation of their shares by the bipolar Mr. Market diminished the investment value of Cisco Systems’ strong operating history. However, now that price is in alignment with earnings (the orange line on the graphs), future shareholder returns should correlate with future business results.

There is a secondary message regarding how misleading statistics can be, as articulated by the normal PE ratio on the following Earnings and Price Correlated Graph. Mathematically, or statistically speaking, the historically normal PE ratio for Cisco Systems since the beginning of 1999 has been 40. However, from the graph it is clear that Cisco Systems’ stock price has not been near a 40 PE since calendar year 2003. Consequently, although the calculation is correct, it would be a meaningless statistic if you got a spreadsheet. We will see the similar anomalous PE relationship on Intel and Microsoft graphs.

The blue line on the following graph shows that Cisco Systems’ PE ratio has been in continuous descent since the irrational exuberant days of the late 1990s. Although earnings have been growing, the PE ratio has been shrinking due to overvaluation.

A useful measure of valuation is the price to sales ratio. Relative to its historical norms, the current price to sales ratio of Cisco Systems is low. This indicates that the shares are currently attractively valued.

When the earnings and price relationship on Cisco Systems is viewed since calendar year 2009, we discover that pricing has become more rational. Moreover, we see the initiation of a dividend in fiscal 2011 (the light blue shaded area) that is growing rapidly (see the light blue highlights at the bottom of the graph). But most importantly, notice that Cisco Systems’ stock price is currently below its earnings justified valuation (the orange line).

Looking to the future, we discover that the consensus of 39 analysts reporting to Standard & Poor’s Capital IQ forecast five year earnings growth of 10% per annum. Crosschecking with 10 analysts reporting to Zacks, forecast five year earnings growth of 9.9%. Consequently, there appears to be a strong consensus for above-average future earnings growth for Cisco Systems.

Intel Corp.

The Intel story is very similar to what was depicted on Cisco Systems above. The big differences are that Intel is historically somewhat more cyclical, but their dividend history much longer. However, I believe the 4.1% dividend yield compensates investors for the more cyclical nature of Intel.

As we saw with Cisco Systems, the historical PE ratio of Intel has been in a steady descent since the irrationally exuberant days of the late 1990s. Again, we discover that Intel went from being significantly overvalued to being undervalued today.

The current price to sales of 2.02 on Intel is one of the historically lowest it has ever traded at. This is in spite of the fact that sales have continued to grow.

Recent earnings growth of Intel has been higher than their historical average at 12.4% per annum since 2009. However, we once again see the more cyclical nature of Intel’s operating history. Nevertheless, we think the current low valuation compensates for the risk from cyclicality.

The consensus of 18 analysts reporting to Standard & Poor’s Capital IQ expect Intel to display a negative growth rate in earnings per share for fiscal 2013. However, they expect earnings to grow again in fiscal 2014 and beyond at approximately 10% per annum. Consequently, Intel appears very attractively priced today. Allow me to remind the reader that the dividend has consistently increased each year in spite of the cyclical nature of operating earnings.

Microsoft Corp.

Our third and final example, Microsoft Corp., illustrates a continuation of what we saw with our previous examples. Mr. Market had ridiculously overvalued their shares during the tech bubble, which created a long and tedious descent in share price as it reverted to the mean. Although Microsoft had very strong operating results, the headwinds of overvaluation destroyed any chance for attractive shareholder returns.

One of the most important perspectives that the Microsoft example provides is how there was such a separation between business results and stock performance. Clearly, Microsoft, the business, performed exceptionally well from 1999 until today. However, because the price was so insanely overvalued, shareholder returns were poor in spite of strong operating results. Finally, it’s interesting that strong operating results generated a continuously increasing dividend.

The following graph shows that Microsoft’s PE ratio has been in a continuous decline since 1999. As the previous graph illustrated, it went from being ridiculously overvalued to now becoming the exact opposite. Microsfots’ stock price moved from the absurd to the sublime.

Along with a falling stock price, Microsoft’s price to sales ratio has continued to drop even though sales have grown. Therefore, Microsoft is currently trading at one of the most attractive price to sales ratios in its history.

When the earnings and price relationship on Microsoft is viewed since calendar year 2009, we discover that pricing has become more rational. Moreover, we see a continuously rising dividend (the light blue shaded area) that has been growing rapidly (see the light blue highlights at the bottom of the graph). But most importantly, notice that Microsoft’s stock price is currently below its earnings justified valuation (the orange line).

Like the two examples before it, Microsoft is expected to grow at above-average rates going forward. A consensus of 35 analysts reporting to Standard & Poor’s Capital IQ forecast 3% earnings growth for fiscal 2013 before accelerating to a 10% growth rate over the next five years. Assuming these estimates are correct, Microsoft shares provide the potential for significant capital appreciation and a growing dividend income stream.

Summary & Conclusions

Buying low in order to sell higher is the first, and perhaps the most important rule of investing. However, human nature being what it is, it also seems to be one of the most difficult of all investing rules to follow. I can remember warning people about how dangerously overvalued the Big 3 – Cisco, Intel and Microsoft were during the tech bubble spanning the mid-90s until early 2000. At that time, I was literally called a dinosaur, told that I did not understand the new paradigm, and my favorite, that valuation didn’t matter anymore.

Those who failed to heed my warnings and aggressively invested in tech lost substantial amounts of money due to their foolish behavior. I believe a similar situation exists today, only in reverse. These great, once high-flying technology growth stocks have now morphed into undervalued blue-chip dividend growth stocks. But once again, we discover that our bipolar partner Mr. Market is choosing to ignore fundamental values by pricing these blue chips significantly below their intrinsic value. As Ben Graham taught Warren Buffett and as Warren Buffett has tried to teach us, exploit other’s folly, don’t participate in it.

— Chuck Carnevale

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Source: FAST Graphs

Disclosure: Long CSCO, INTC and MSFT at the time of writing.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.