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A Tech Value Play

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

A few years ago I traveled to Shanghai, China to study “Doing Business in China” as part of a group of future Penn State MBAs.  As we were traveling to our hotel from the airport, the first thing that I noticed was that there were Hooters Restaurants in “Communist China.” 

Or maybe they were just in Shanghai, China because when I went to Beijing I didn’t see any.  After all, there is a sharp contrast between the two cities: Shanghai is capitalistic and entrepreneurial whereas Beijing is still very communistic. 

My 3 weeks in China were eye-opening.  We met with officials from the Chinese Government who explained to us how US companies like Starbucks, McDonald's, and Ford do business in China: through Joint Ventures. 

Then Penn State alums gave us tours of facilities and told us what doing business in China was like.  One of the facilities that we toured was an Intel manufacturing plant.  That facility was impressive.  Overall, my impression of Intel was very favorable. 

My Perspective as an MBA Student

My takeaways were simple: (1) Intel (NASDAQ: INTC) is about as close as you can get to a monopoly (which are generally good investments) except for maybe Microsoft (NASDAQ: MSFT) and (2) doing business in China is tough for any company.  Out of all of the companies that we visited, I remember feeling that Intel had the most talented employees, the largest barriers to entry, and the best plan for doing business in China. 

So how does Intel stack up against Microsoft?

                                                                Intel                                    Microsoft

Price to Earnings                                   9.5                                        14.3

Dividend                                                4.2%                                      3.5%

Gross Margin                                         64%                                       75%

Current Ratio                                          2.7                                          1.9

Market Cap                                        $223 Billion                          $108 Billion

My Perspective Years Later

I still think that Intel is an iconic brand, as close to a monopoly as you can get, and potentially a very solid investment.  But a lot has happened to the sector and there is a lot is going on internally at Intel, namely Intel is looking for a new CEO because Paul Otellini has decided to retire early.  That said, I learned a very long time ago that only fools purchase stocks without validating their beliefs with data and solid facts.  So let’s delve into the data and the details.

The Data and the Facts

Admittedly, it is surprising to see all of these dot com companies like Intel paying dividends and getting lumped in with the value stocks.  A few years ago it appeared as though these companies would grow forever – or at least that is what their valuations suggested.

The first thing that I noticed about Intel was its valuation.  This company has a P/E ratio of around 9 and a forward P/E ratio of approximately 11.  Those are both well below the S&P average. 

Next I looked at Intel’s 5-year average growth rates: revenue growth of 8.8%, net income growth of 20.7%, and dividend growth of 14.4%.  Based on the numbers, it looks like the company has its priorities in check.  In other words, well run companies prioritize earnings growth over sales and volume growth.        

Then I dug a little deeper into Intel’s balance sheet and income statement.  A cursory look at Intel’s balance sheet showed that Intel has over $10 billion in cash & short term investments.  A more thorough analysis of Intel points to a valuation in the high $20’s to low $30’s. 

That considers additional factors such as a historical P/E ratio of around 15, which is in line with the S&P; a cash flow from operations that was over $20 billion in 2011; and a strong return on equity of around 25%, which is a very strong indicator of “sustainable profitability” and points to a well-managed operation. 

An important indicator of management efficiency is Economic Value added, or EVA, which measures a company’s true return to shareholders after factoring in not only the cost of running operations but also the cost of capital that the company employs. 

To cut to the chase, Intel has a weighted cost of equity that is much larger than its weighted cost of debt.  When combined the total cost of Intel’s capital is still quite low (slightly more than 7%) compared to its total return on invested capital (around 28%).  That means that Intel has a very high EVA of over 20% – which represents a very high return to shareholders given that all of the costs of capital were subtracted out.            

The largest risk that I came across with Intel is concern over the next CEO.  There is a lot of chatter and speculation on whether or not Intel will promote from within or poach talent from somewhere else, whether or not Intel will prioritize experience in mobile and the cloud over CEO experience, and whether or not Intel will attempt to go after Pat Gelsinger, who appeared to be a logical CEO candidate until he left the company in 2009. 

This decision is all the more important given Intel’s relaxed push into the mobile space, the fact the majority of analysts seem to have written off the PC business, and the highly discussed but not well understood cloud computing space.

A Compelling Valuation

Although I would love to see Intel’s architectural roadmap and strategic plan, even without those or other documents, I feel that this company is very attractively valued given that it is currently hovering around $20 per share. 

This is a company with an outstanding balance sheet, a very strong brand, market share leadership, strong margins (although diluting a bit), and footholds in emerging markets, which should allow Intel to grow alongside emerging markets and at a minimum offset negative growth in more mature markets longer term.  

3 Reasons to Consider Purchasing Intel

  1. A compelling valuation.  Intel is selling at well below its historic P/E multiple.  Intel also pays a hefty dividend of more than 4%.  Plus Intel has consistently found ways to grow.           
  2. A dominant position in the market.  Intel controls approximately 80% of the market for microprocessors.  Intel has scale and is practically a monopoly.             
  3. A beaten down sector.  The tech sector was badly beaten down.  The majority of analysts, however, are now overweighting the sector, which should benefit companies like Intel.

My Foolish Take

On the negative side, there is a lot of uncertainty surrounding Intel: Who is going to be the next CEO?  What is Intel’s strategy for the mobile space?  Will Intel go on an acquisition boom?  Can Intel maintain its margins?  Can Intel successfully move into the cloud computing space?  Can Intel continue to grow?  Could even a string of very positive announcements move investor sentiment?

On the positive side, Intel has a track record for delivering results, a sustainable dividend, a strong brand, a ton of cash on hand, and a dominant position in the market. 

On balance, at a price point around $20 per share I feel that Intel is very attractively valued.  Patient investors could reasonably expect a healthy total return in the 20-30% range over the next few years with minimal downside risk given that arguably too many negative assumptions are built into Intel’s current valuation. 

RyanPeckyno is long Intel. The Motley Fool recommends Intel Corp. The Motley Fool owns shares of Intel Corp. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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