Sharing Knowledge in Smallcaps

[Frank Pembleton]

Vox: Intel -- INTC
By FABRICE TAYLOR
From Tuesday's Globe and Mail

You'll find them in newspapers and magazines, on television, at conferences and at the barbershop: Pundits who tell you to buy stocks that have fallen drastically because a) "they're cheap" and b) "there's a real business there."

By now, most investors — who before this bear market knew only salad days — have learned that stocks don't automatically become cheap when they fall and that "a real business" is only worth buying at the right price. The boosters haven't disappeared — at least not enough of them — but their audience has waned, which explains why they're trying to convince you that they've been bearish all along. How many strategists are revisiting their Fed-model-based calls to buy stocks?

Intel's a good example of the kind of mistakes investors make. The stock does look cheap at $14 (U.S.) if you remember only that it averaged around $40 in the thick of the bull market. But back then, the shares were quoted at a mere 30 times earnings. Down 80 per cent from their peak, they're just as expensive today.

You won't have to look far to find someone willing to explain to you that you have to 'normalize' the earnings, that is, price the stock on the profitability of the company over the economic cycle. That's true, but this same person wasn't advising you to temper your expectations when the cycle was at the top.

At any rate, to cure yourself of the temptation to see cheapness where there is only correction, forget the stock price and think of the value of the entire business. Intel has a diluted share count of 6.8 billion for a market cap of more than $95-billion (there's virtually no debt).

So you could buy Intel for that much (ignore the control premium) or you could buy a bond portfolio made up of 10-year notes, which would earn a return of about $3.5-billion annually at current yields, guaranteed by the U.S. government.

Intel is not a bond portfolio; it's an enterprise (an excellent one) engaged in the risky business of making technology. Needless to say, you probably wouldn't settle for a 4-per-cent return given the risks, mitigated though they may be by Intel's superlative economies of scale. You'd want more than that. Let's say you figured you deserved 12 per cent. What would Intel owe you?

That depends on how much growth it could squeeze out of its dominant business position. Since it's hard to find an analyst report on the company that doesn't have the word "mature" in it in one form or another, we'll assume the company can't grow at a much faster rate than the economy over time.

Let's say 6 per cent on average (which is considerably more than the economy).

If Intel stopped growing at double-digit growth rates, it could afford to pay out more in dividends — or it could keep aggressively buying back shares, as it has been doing.

Amazingly, the share count has actually risen, thanks in part to option grants.

Assuming it could pay out 40 per cent of its profits (which is more than some quality banks), according to the trusty dividend discount model, the company would have to make $14-billion (on a normalized basis) next year to justify its current price. The company has never come close to making that much money and with deflation in technology, it probably never will.

So insist that there's a real business there, predict it will triple, make money any way you can. But don't call Intel cheap.

http://www.globeandmail.com/servlet/ArticleNews/business/RTGAM/20021008/wxvox8/Business/businessBN/b....