(Excerpt from my October 2008 "From The Bleachers" Newsletter)
Perhaps this is a good time to shift to the topic indicated by the title up above, before readers decide we’re just a bit off the mark with it. Our fervent hope is to both entertain and educate our readers on the art of stock picking for – as the title declares – it is a market of stocks not a stock market in which we invest. To be fair, we are contrarian by nature, and a bit old fashion to boot. We recognize that index funds exist, that exchange traded funds are available with which to place your bets on red, black, or even green, but we prefer to build a portfolio the old fashion way, one well researched stock at a time. We hesitate to declare that we’re looking for an undervalued business in which to invest since we will almost assuredly be (mis)labeled as a value investor. So we will avoid the claim. Rather, we simply recognize that a share of stock means a share of ownership in a corporation which entitles the stock holder to a share of the profits, should there be any.
Now oddly enough, we have found over the years that companies that make increasing amounts of money are deemed more valuable (eventually) to investors than those who don’t, and the stock price of said company invariably rises over time as a result of the increasing stream of cash finding its way into the shareholders’ pocket, a truly wonderful outcome for those of us who enjoy turning a profit with our investing. It is our belief that we are buying ownership in a business that guides our search. Not for us the pursuit of a stock, simply because it is rising – that game belongs to the many speculators who invest with a six to twelve month time horizon. Speculators they are because they invariably buy a stock in the hope that it will trade higher in the coming quarters, allowing them to sell at a tidy profit and move on to the next piece of paper. The many mutual fund managers, institutional asset managers, and individuals who choose to rent a stock (and we are now fairly describing upward of 90% of the investors out there) are not interested in the value of the underlying business. They care only whether the stock price will rise in the short run, and turn to such devices as earnings revisions, upside surprises, relative strength indicators and insider buying to divine the short term future of a company’s stock price. We, on the other hand, care very much what price we pay for a company. Just as we choose not to overpay for a car, house, vacation, or that big flat panel TV that makes Peyton Manning’s flapping and stomping prior to the snap looking even more like a blue heron dancing in the shallows (Of course we are fans, season ticket holders as a matter of fact).
Don’t misunderstand however. We have owned all manner of stocks in our 20 years of investing. Technology stocks, drug companies (back when big pharma was considered a growth industry), the King of Beers, and the royalty of soda pop (Coke) have all found their way into our portfolios. We will buy anything in any industry if the price is right, and we are very patient in waiting for that happy event to occur. For instance, Coke was the poster child of expensive back in the late 1990’s, peaking in the vicinity of 55 times earnings if we remember correctly. We even used it as a marvelous example of a great company that was no longer a great investment. But we didn’t hesitate to pay some 20 times earnings in 2005, with the stock in the low 40s, nor did we hesitate to sell it some two years later in the high 50s when the price-to-earnings multiple no longer matched the company’s growth prospects. A market of stocks, not a stock market, and stocks as certificates of ownership in an ongoing business – two of the guiding principles of our investment philosophy.
INTC $14.28
Intel closed today at $14.28 per share, but not before touching $13.37 intraday – a new 52-week low. The company is paying a dividend of $0.55 per share for a current yield of 3.85% and is expected to raise its dividend to $0.61 per share in 2009, according to Value Line – should reality meet expectations INTC will yield 4.27% for anyone buying at the current price, or some 40 basis points or so more than the 10-year Treasury. Now, of course, Intel common stock is riskier than holding a 10-year Treasury to maturity (although that premise seems increasingly uncertain given our government’s loose spending habits). On the other hand, we get much more than a debt instrument that pays par upon maturity when we buy part ownership of a company. We also get a growing stream of shareholder cash flow that can be returned to us by management either with increasing dividends, share buy backs or both.
In fact, INTC will pay out around $1.19 per share in 10 years if management raises the dividend 8% per annum during that period – only one quarter the growth rate of the last 5 years. Anyone buying and hold Intel’s stock for the decade will then be earning 8.3% per annum on their original investment. Now compare that juicy 8.3% to the measly 3.85% you can currently earn holding the U.S. 10-year note… and you quickly get it – Intel is a raging buy at the current price as long as the company is around in 10 years and as long as management is able to continue to grow the dividend. And our analysis doesn’t yet include the possibility of additional cash that might be available to oh, say, buy in stock, resulting in the dividend yield rising even faster.
In Intel’s case, a quick check of current year estimates reveals that the company will have approximately $0.55 per share in excess cash after paying its dividend and meeting its capital expenditure requirements. A three year average is often useful in ascertaining a company’s ability to throw off excess cash consistently. According to Value Line, Intel has generated approximately $5.66 in cash flow from 2006 to 2008, while making $2.76 per share in capital expenditures and paying out $1.41 per share in dividends, leaving approximately $1.49 per share in excess cash available to buy back shares, or $0.50 per share per annum. Adding the $0.50 in excess cash to the current $0.55 dividend gives you a current dividend yield of 7.35% (what the dividend yield would be if INTC management devoted all of its excess cash to the dividend). Unfortunately, Intel, like many management teams often choose to buy back shares with excess cash. We think it unfortunate, because managers tend to pay top dollar for their own shares rather than waiting to buy in shares after their stock takes a dive. Nevertheless, buying in $0.50 per share per annum retires 3.5% of the outstanding shares at the current stock price (call it 2.0% net of stock option issuance), raising current and future dividends accordingly.
Yet another way to do the math without the distortion of a changing share count: Intel generated $34.2 billion in Cash Flow After Taxes (CFAT) during the three years ending in 2007, against $17 billion in Capital Expenditures (CAPEX), leaving $17.2 billion available to shareholders. The entire company was available for purchase for a mere $154 billion at the beginning of 2008 (you could buy it lock stock and barrel right now for $82.8 billion). Taking the three year average shareholder cash number of $5.7 billion and dividing it into the current fully diluted shares outstanding gets you $0.99 per share in stockholder available cash – a nice current yield of 6.9%, some 3.1% better than the 10-year’s current yield.
A couple ways then of looking at the yield to shareholders currently and a decade into the future in comparison to the 10-year Treasury – all favorable. We just need to make a judgment on whether INTC is likely to be around and prospering a decade from now.
The company is currently the world’s largest semiconductor chip maker based on revenue, according to its 2007 10K SEC filing. INTC develops advanced integrated digital technology products, primarily integrated circuits, for industries such as computing and communications. Intel also develops platforms, which they define as integrated suites of digital computing technologies that are designed and configured to work together to provide an optimized user computing solution compared to separately. Intel currently controls about 80% of the PC processor market.
For starters, Intel has grown revenues from $30.1 billion in 2003 to an estimated $40.4 billion in 2008, or a little over 34% during the five year period. Net profit is forecast to hit $7.3 billion in 2008, up from $7.0 billion in 2007 but well off the company’s peak profit logged in 2000 ($10.7 billion). Nevertheless, profit has grown steadily, albeit erratically, since the bottom fell out during the last recession in 2001 (profits bottomed in 2002 at $3.5 billion).
Clearly the company is likely to still be in business and growing earnings given its dominating position in the microprocessor industry and strong balance sheet (almost 13 billion in cash on the balance sheet at the end of 2007). On the other hand, just looking at the increasing variability in earnings leads one to the conclusion that the company is no longer a true growth company and should be bought after business conditions (and the stock price) have weakened and sold when investor enthusiasm carries the share price outside of the realm of reasonable valuation. We believe the current valuation is in the buying zone, given our discussion of dividend and shareholder yields.
