The Market Is Betting Big on ORCL - What's the Catch?

Software company Oracle stunned Wall Street today as it surged to $121.85, marking a 4.4% change compared to the S&P 500 and the Nasdaq indices, which logged 0.0% and 1.0% respectively.

ORCL currently sits within range of its analyst target price of $120.56, which implies that its price may remain stable for the near future.

Surprisingly, analysts give the stock an average rating of buy, which shows that they believe prices could continue to move. Over the last year, Oracle shares have outperformed the S&P 500 by 52.0%, with a price change of 67.4%.

Oracle Corporation offers products and services that address enterprise information technology environments worldwide. The companyis in the technology sector, which groups together a wide range of industries including consumer electronics, software, computer hardware, scientific instruments and IT services. Legendary investor Warren Buffet once stated that he would never invest in technology companies. Apple is now one of his largest holdings.

The risks inherent to the technology sector are clear, but investors simply cannot ignore the potential for strong returns. Even with the lessons learnt in the 2000 tech bubble, the market continues to highly value the promise of technological innovation and the ability for these companies to build and occupy new markets.

Oracle's trailing 12 month P/E ratio is 40.2, based on its trailing EPS of $3.03. The company has a forward P/E ratio of 19.3 according to its forward EPS of $6.3 -- which is an estimate of what its earnings will look like in the next quarter. The average trailing Price to Earnings (P/E) ratio of US-based technology companies is 27.16 as of first quarter of 2023. In contrast, the S&P 500 average is 15.97. The P/E ratio is the company's share price divided by its earnings per share. In other words, it represents how much investors are willing to spend for each dollar of the company's earnings (revenues minus the cost of goods sold, taxes, and overhead).

Oracle's P/E ratio tells us how much investors are willing to pay for each dollar of the company's earnings. The problem with this metric is that it doesn't take into account the expected growth in earnings of the stock. Sometimes elevated P/E ratios can be justified by equally elevated growth expectations.

We can solve this inconsistency by dividing the company's trailing P/E ratio by its five year earnings growth estimate, which in this case gives us a 1.83 Price to Earnings Growth (PEG) ratio. Since the PEG ratio is greater than 1, the company's lofty valuation is not completely justified by its growth levels.

To better understand the strength of Oracle's business, we can analyse its operating margins, which are its revenues minus its operating costs. Consistently strong margins backed by a positive trend can signal that a company is on track to deliver returns for its shareholders. Here's the operating margin statistics for the last four years:

Date Reported Total Revenue ($ k) Operating Expenses ($ k) Operating Margins (%) YoY Growth (%)
2023-05-31 49,954,000 22,617,000 27.57 -26.09
2022-05-31 42,440,000 17,733,000 37.3 -4.33
2021-05-31 40,479,000 16,842,000 38.99 7.26
2020-05-31 39,068,000 16,928,000 36.35 n/a
  • Average operating margins: 35.1 %
  • Average operating margins growth rate: -6.7 %
  • Coefficient of variability (lower numbers indicate less volatility): 14.6 %

Oracle's financial viability can also be assessed through a review of its free cash flow trends. Free cash flow refers to its operating cash flows minues its capital expenditures, which are expenses related to the maintenance of fixed assets such as land, infrastructure, and equipment. Over the last four years, the trends have been as follows:

Date Reported Cash Flow from Operations ($ k) Capital expenditures ($ k) Free Cashflow ($ k) YoY Growth (%)
2023-05-31 17,165,000 -8,695,000 8,470,000 68.46
2022-05-31 9,539,000 -4,511,000 5,028,000 -63.44
2021-05-31 15,887,000 -2,135,000 13,752,000 18.81
2020-05-31 13,139,000 -1,564,000 11,575,000 n/a
  • Average free cash flow: $9.71 Billion
  • Average free cash flow growth rate: -7.5 %
  • Coefficient of variability (lower numbers indicating more stability): 39.1 %

With its positive cash flow, the company can not only re-invest in its business, it can offer regular returns to its equity investors in the form of dividends. Over the last 12 months, investors in ORCL have received an annualized dividend yield of 1.2% on their capital.

As of first quarter of 2023, Oracle is likely overvalued because it has an inflated P/E ratio, no publishedP/B ratio, and consistent free cash flow that are on a downwards course. The stock has strong growth indicators because of its strong margins with a negative growth trend, and an inflated PEG ratio. We hope this analysis will inspire you to do your own research into ORCL's fundamental values -- especially their trends over time.

The above analysis is intended for educational purposes only and was performed on the basis of publicly available data. It is not to be construed as a recommendation to buy or sell any security. Any buy, sell, or other recommendations mentioned in the article are direct quotations of consensus recommendations from the analysts covering the stock, and do not represent the opinions of Market Inference or its writers. Past performance, accounting data, and inferences about market position and corporate valuation are not reliable indicators of future price movements. Market Inference does not provide financial advice. Investors should conduct their own review and analysis of any company of interest before making an investment decision.