Why Microsoft And Intel Investors Should Be Glad The Stocks Are Languishing

Mar. 1.13 | About: Intel Corporation (INTC)

Microsoft (NASDAQ:MSFT) and Intel (NASDAQ:INTC) investors should be glad the stocks are languishing. Investors should hope the stocks continue to underperform in the market.

Let's look at the 10 year price charts for each:

Microsoft

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Intel

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The red lines in each chart show my average cost basis in each company. As the charts show, the stocks have been range bound for the past 10 years and are averaging near my cost basis. In fact, as of today's prices I'm about breaking even.

How can this be a good thing and a reason to be glad? The reason lies in the fundamental differences between an investor and a speculator.

An Investor Versus A Speculator

An investor will diligently study a company and decide on the company's intrinsic value, and only make an investment in the company when the stock is trading at a fair value or - even better - at a substantial discount to the company's intrinsic value. Once the investment is made, the fluctuations in stock price shouldn't matter to an investor other than providing opportunities to make further investments at lower prices. Certainly, an investor shouldn't want the stock price to rise as this would make future investments in the company more expensive. An investor makes investments in a company to share in the company's profits. A speculator makes profit or takes losses due to the up and down movements of the company's stock price. I am an investor in Microsoft and Intel. I am not a speculator of the companies' stock prices.

Why I Invest in Microsoft and Intel

I invest in large companies with competitive advantages and solid balance sheets. I look for companies with a history of stable and rising dividend payments and solid share buyback programs. These companies are committed to providing shareholder returns and are ideal long term investments if bought at a good price. I employ dividend growth compounding in my portfolio and believe having a diversified group of blue chip stocks is an important part of managing risk. Dividend growth investors should consider Microsoft and Intel for exposure to the technology sector, especially at these attractive valuations.

Microsoft and Intel are under pressure due to a weakening in PC sales and being late into the mobile market however both companies have adjusted their strategies accordingly and are constantly innovating to remain dominant companies in their industries. Both companies still retain wide economic moats, and both still have solid business fundamentals. Despite the recent pressure, both companies have continued to produce billions in revenue and net income. With abundant cash and cash flows there are no signs either company will stop raising their dividends or eliminate their share buyback programs. I will continue to invest in Microsoft and Intel until either of these risks become apparent.

Dividends

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Both companies have a history of stable and rising dividend payments. Microsoft has a current dividend yield of 3.31% and Intel has a yield of 4.31%. These are both attractive starting yields. Microsoft has a dividend payout ratio of 38% and Intel's is 41%. With low payout ratios both companies can easily sustain and increase dividends.

Share Buybacks

Microsoft has been steadily buying back shares, as we can see from annual reports. Microsoft has bought back 1,689 million shares from 2008-2012. Microsoft spent $46.918 billion dollars buying back these shares at an average price of $27.78 per share.

According to Intel's share buyback program, Intel has bought back 1,315 million shares from 2008-2012. Intel spent $29.186 billion dollars buying back these shares at an average price of $22.19 per share.

Both companies have shown a stable history of share buybacks and are committed to buying back more shares in the future.

Valuation

Microsoft and Intel are both undervalued.

Here's a snapshot of Standard & Poor's stock report for Microsoft:

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S&P's Fair Value Rank for Microsoft is 5, which means it is most undervalued. Their Fair Value Calculation is $37.30. S&P also gives Microsoft a 99 Investability Quotient Percentile, which is a measure used by S&P to describe how good a company's medium to long-term return potential is.

The financial ratios for Microsoft are all below industry average:

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Here's a snapshot of Standard & Poor's stock report for Intel:

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S&P reports Intel's Fair Value Rank is 5 (most undervalued). Their fair value calculation is $24.20. S&P gives Intel a 98 Investability Quotient Percentile.

The financial ratios for Intel are also below industry average:

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A simple valuation I like to use is seeing how much on average the companies are buying back their shares through buybacks. Microsoft has bought back shares at an average price of $27.78 per share the past 5 years and Intel has bought back shares at an average price of $22.19. I'm comfortable adding to my positions any time below these prices.

Why I Am Glad The Stocks Are Languishing

I am glad the stock prices are languishing because this allows me to acquire a bigger stake in each company. Low stock prices allow me to buy more shares. My stake in each company increases through reinvesting dividends, through direct future purchases with my own money, and through the companies' share buyback programs. In each case, low stock prices will allow more shares to be bought and are beneficial to me as an investor.

Let's Do The Math

Taking Intel as an example, from 2008-2012 Intel has spent an average of $7.3 billion dollars a year buying an average of 329 million shares each year. Intel recently issued $6 billion in bonds to fund further stock buybacks. Given the low rate of borrowing money this is a smart decision by Intel because they are borrowing money and buying back shares for less than it would cost them to keep the shares outstanding and pay the 4.31% dividend yield.

Let's say an investor owns 50 million shares of Intel. With about 4.96 billion shares outstanding, this investor owns about 1.008% of the company. Let's assume Intel stays close to the yearly average and spends $7 billion dollars buying back stock in 2013. Let's also assume the investor reinvests dividends and invests an additional $8 million in 2013.

If the stock languishes near $20 throughout 2013 Intel will acquire about 350 million shares with the $7 billion spent on share buybacks. This would leave about 4.61 billion shares outstanding. The investor can buy 400,000 additional shares with $8 million, resulting in the ownership of 50.4 million shares. For simplicity of calculation, let's assume the investor receives Intel's $.90 per share annual dividend all at once and reinvests those dividends. The investor would receive $45.36 million and reinvests to buy 2,268,000 more shares. This results in the investor owning 52.7 million shares. With 4.61 billion shares outstanding due to the share buybacks the investor would now own about 1.142% of the company by the end of 2013.

Let's look at the results if the stock were to average $30 per share throughout 2013 instead of $20. Intel would acquire about 233.3 million shares with the $7 billion spent on share buybacks. This would leave about 4.727 billion shares outstanding. The investor can buy about 266,667 additional shares with $8 million, resulting in the ownership of 50,266,667 shares. The investor would receive $45.24 million in dividends and reinvesting would buy 1,508,000 more shares. This results in the investor owning a total of 51.775 million shares. With 4.727 billion shares outstanding due to the share buybacks the investor would now only own about 1.095% of the company by the end of 2013.

If Intel were to earn $30 billion in 2013 the investor's share of those earnings would be $14.1 million greater if the stock price languished at $20 than if it increased to $30. An investor should prefer the stock price to languish at $20.

Warren Buffett Would Agree

Warren Buffett explains in his 2011 letter to shareholders of Berkshire Hathaway why investors in companies that are repurchasing shares should hope for the stocks to underperform in the market for a long time. In the letter, he gives his investment in IBM as an example why he prefers low stock prices and I have sought to replicate his example with the above calculations for Intel. Warren Buffett explains that if you are going to be a net buyer of stocks in the future either directly with your own money and reinvested dividends or indirectly through your ownership of a company that is repurchasing shares then you are hurt when stocks rise. You benefit when stocks languish because this allows you to buy more shares with your money and allows the companies to repurchase more shares with their money. Most people including those who will be net buyers in the future let emotions get the better of them and are glad when they see stock prices rise. As Warren Buffet said, "these shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day's supply."

Conclusion

Microsoft and Intel investors should heed Warren Buffett's words and be glad the stocks are languishing. Instead of this being a reason to stop investing in Microsoft and Intel it should be a reason to invest even more. Low stock prices allow investors to own a greater percentage of these companies than higher stock prices would allow. Low prices also make dividend compound growth more effective since the dividends can buy more stock and earn even more dividends. This idea is in opposition to someone who is speculating in the stock prices of Microsoft and Intel. Investors should carefully consider if they are investing in these companies or speculating on the stock prices. We all praise Warren Buffett's success but few seem to truly follow his investment path. He would say that investors in Microsoft and Intel should be glad the stocks are languishing and should hope for the stocks to continue to underperform in the market. I agree and will continue to add to my positions at these attractive valuation levels.

Disclosure: I am long MSFT, INTC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.