3 Ways to Play the Death of the PC

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

“The death of the PC,” I think if most investors had a nickel for every time they have heard this phrase, they wouldn't need to invest anymore because they would be rich. For years people have been predicting the death of this industry and it just keeps on going. The problem is, many of the people calling for the death of the PC industry look primarily at the United States and not worldwide demand. While it is certainly true that PC sales have slowed, and the huge growth in smartphones and tablets threatens to dwarf PC sales, this doesn't necessarily mean the death of the industry.

News Flash! – The PC Isn't Dying:

Here is the thing, most of the forecasts for the death of the PC talk more about the growth in tablets and smartphones than PC sales. Contrary to popular belief, PC sales are not dying off. I've written about this before. In 2010 there were 350.9 million PCs sold, by 2011 this number increased to 352.8 million, and by the end of 2012 sales are expected to reach 367 million. In addition, even after cutting estimates, IDC Research is calling for at least 6.5% growth in the PC industry from 2013 to 2015.

There is a misconception that a slower growing industry is dying. Peter Lynch made this point years ago, when he said that industries go through cycles. He mentioned that years ago plastics, utilities, grocery stores, and other businesses passed from fast growth to slower growth. Just because an industry slows down doesn't mean you can't find attractive investments there. In fact, Lynch said he actually looked for companies that were dominating their fields in slower growing industries. He preferred this setup because the companies don't have to spend tons of money defending their business and they can use their cash flow to repurchase shares and increase their dividend. In the PC industry, there are three prime candidates that are benefitting from their dominance and generating huge cash flow. While some investors might think they have heard these ideas before, hear me out.

No Longer Fast Growth, But Good Growth & Income:

The first company set to deliver good returns to shareholders in this “dying” industry is Intel (NASDAQ: INTC). Intel isn't the huge growth machine that it used to be, but instead is a good growth and income play. Since there is so much uncertainty surrounding the future of the company, the market has marked down the shares to a yield of over 4%. In addition, Intel is predicted to grow earnings per share by nearly 12% in the next few years. If history is any guide, Intel might actually do better than analysts expect, as the company has beaten expectations by almost 8% per quarter in the last year.

In addition, Intel is a cash generating machine. The company produced over $2.2 billion in free cash flow in spite of a significant increase in research and development expense in their most recent quarter. While many have expressed concerns about Intel's reliance on the PC industry, the company is shifting its focus towards tablets, smart phones, and the new Ultrabook category. Intel's CEO Paul Otellini said, “The world of computing is in the midst of a period of breakthrough innovation and creativity. As we look to the fourth quarter, we're pleased with the continued progress in Ultrabooks and phones and excited about the range of Intel-based tablets coming to market.” While the transition from being a PC supplier to being a supplier in all forms of computing will not happen overnight, investors are being paid handsomely to wait for Intel to dominate the computing industry as it evolves.

I Know What You Are Thinking – Microsoft Really?

Many people hear the name Microsoft (NASDAQ: MSFT) and immediately stop listening. However, if you think about it, there's no more obvious choice to benefit from the continuance of the PC than Microsoft. The last time I checked, the company still runs roughly 90% of the world's computer systems. In addition, a huge percentage of companies rely on Microsoft Server, and just as many use Microsoft Office every day. While some are counting on the Xbox and online divisions as the future of the company, it doesn't appear that's where Microsoft should be focusing. When you consider that the company's Server and Office divisions both continue to show solid growth, there's no reason for the company to move their focus from these two highly profitable divisions.

While some question whether Windows 8 will be a hit for the company, it at least shows the company is willing to take a chance. Whether it's Windows 8, Windows 9, or some future operating system, there just isn't a great alternative for the majority of users to switch to. I'm a big fan of Apple and believe many people could switch to their operating system fairly easily. However, the company's pricing precludes a lot of cheap hardware from hitting the market, and making OSX a more mainstream operating system. What should get investors really excited about Microsoft is the companies almost ridiculous free cash flow. In the most recent quarter, the company generated over $7.8 billion in free cash flow, and currently sits on over $66 billion worth of cash and investments. With the stock paying a yield of about 3.25%, and a 21% free cash flow payout ratio, Microsoft clearly has the free cash flow to continue to raise the dividend significantly. Whether Windows 8 is a hit or not, the potential for dividend growth at this company should make the stock a hit for investors.

A Hard Drive Maker?

For those of you who would balk at my suggestion of Microsoft as a potential investment, I'm sure you'll have trouble with this one as well as Seagate (NASDAQ: STX) appears to offer tremendous value at these levels. The bottom line is, the company has a nice dividend at over 4.5%, and plenty of free cash flow to continue raising this yield. In the most recent quarter, the company generated about $1.3 billion in free cash flow and paid out just over $100 million in dividends.

If researchers are correct at IDC, the PC market should grow to about 400 million PCs next year and continue to show mid single-digit growth for the next few years. As one of the two largest hard drive manufacturers, there is a very good chance that Seagate drives will reside in many of these PCs. In addition, I would say it's very likely that Seagate will make an acquisition of a solid-state drive manufacturer. This would help the company move away from just traditional hard drives, and give them a chance to compete in PCs, tablets, and smart phones. While analyst are calling for EPS growth of just 5.5% over the next few years, collecting a 4.5% yield that should be raised significantly sounds pretty good to me.

Conclusion:
You may have noticed all three of the companies I'm suggesting share similar traits. First, they all produce significant free cash flow which can be used for share repurchases and increased dividend payments. Second, each company suffers from the belief that their offerings are behind the times. Third, each company is set to benefit from the continued growth of the PC industry. Sometimes in investing it's not the wild headlines that you should pay attention to, but instead the cold hard facts. In this case, the facts suggest the PC industry will do fine and so will these three companies.

Dig Deeper

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MHenage owns shares of Intel and Seagate Technology. The Motley Fool owns shares of Intel and Microsoft. Motley Fool newsletter services recommend Intel and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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