My favorite type of stock is that of a tiny company that very few people know about and that isn't covered by Wall Street. This isn't one of those. However, I also like to pick up the big ones if they are a little or a lot out of favor for the wrong reasons. At these times, I'm tempted by the blue chip names, even if they don't offer the same potential for gains as the smaller stocks, because they are less volatile, and that is worth something too.
For my blue chip names, I like to take the modern Buffett approach or in the school of the late Philip Fisher (put into simple enough rules in his book Common Stocks and Uncommon Profits). Both approaches come down to the same tried and tested approach:
Buy great companies and hold them.
The reason why I think Intel Corp (NASDAQ:INTC) is a great company is because the company has secured one of the few true competitive advantages. With all my blue chip selections - inspired by Fischer and Buffett - I'm looking for wide moats that protect their businesses.
Columbia University Professor Bruce Greenwald gave me a framework I'm comfortable with to analyze competitive advantages. His down-to-Earth but solid writing made me a big fan of his book: Competition Demystified: A Radically Simplified Approach To Business Strategy. In this book, he identifies the few real competitive advantages.
One of them is the well-known economy of scale. That's exactly the competitive advantage Intel enjoys. According to Morningstar the company holds a 80% market share in the microprocessor market.
The R&D budget is a crucial recurring investment a company competing in the microprocessor market has to make. Because of their scale advantage, Intel can make bigger investments than its competitors and spread the costs over more units. Not only is their technology more likely to be cutting edge, it also gives them pricing power.
Then Why Is Intel Under Pressure?
If I have to place myself into a camp of investors, it would be into the value investment camp. You can read more of how I approach investing on my blog. For a value investor to become interested a company, it usually needs to be in some sort of a crisis. Intel is not exactly in a crisis, but given its wide moat and dominant market share, its valuation is modest at a P/E of 12. With an earnings growth over the past 10 years of 13.5%, that is not expensive. The market is not looking favorably at its future.
This pressure on the stock price is there because of the explosive growth of the use of tablets. This growth has been cutting into PC sales. Intel is dominant in PC chips, but is a small player in tablet and mobile chips. In mobile devices, chips that are great power efficient processors have the edge over pure processing power. Currently, competitors like ARM Holdings Plc (NASDAQ:ARMH) are better at making these.
But to quote Morningstar analyst Andy Ng:
The Atom processors are becoming much more competitive in power efficiency, which should allow Intel to achieve more design wins in tablets and smartphones and ultimately encroach upon ARM's turf in the next year or two.
Intel's Atom processors are being used by Motorola Mobility and Lenovo. Samsung used an Atom processor in its Galaxy Tab 3 10.1 inch version.
Research budget Intel vs research budget ARM
According to their latest annual report, Intel spent over 10 billion USD on research and development in 2012 alone, while ARM reports a percentage of revenue spent that would make their R&D budget go just over $ 250 million. A very respectable number, but there is still a wide gap.
Another interesting development that is not highlighted enough is that as consumers and businesses increasingly use tablets. PC sales do go down, but at the same time, the move towards cloud computing is sped up. In cloud computing, the processing power for applications is shifted away from the handheld device to the server park.
When computing power is more and more drawn from the cloud, this enables software developers to start pushing for the limits. They no longer have to design software while keeping in mind consumer machines that are limited in processing power.
At the same time, the increase in mobile devices enables consumers to spend more time - because computing power is now available to them everywhere - drawing processing power.
Intel itself says this in their latest annual report:
We also believe that increased Internet traffic and the increased use of mobile and cloud computing create a need for an improved server infrastructure, including server products optimized for energy-efficient performance.
That power is coming from industrial server parks. To serve this emerging need, there will be large investments into this market. A market where Intel is dominating.
Intel will be able to leverage its scale advantages to the fullest here. So while tablets and other mobile devices threaten Intel's hegemony on one side, they push the cloud based computing power services forward. This is where Intel is strong.
What I'm saying is: consumers moving from PC to mobile devices - while Intel is lagging in that space - is not as bad as it sounds.
No matter how great a company or how deep and wide its moat, it all comes down to one question: How much?
Intel sells for $ 22.28 with earnings per share at $1.85, That puts Intel's P/E around 12. Price/Book value is 2. See the Intel yahoo finance page for a wide variety of fundamental statistics.
To be of further assistance, I've done a DCF analysis on Intel which turned out to be encouraging. The result of a calculation like this is very dependent on your input, and if you disagree with the input, the numbers mean very little. That's why I'm taking you through some of the numbers I put in even though not all readers enjoy that.
I've based my calculation on Intel's future growth rate on net-income growth rate over the last 10 years. You could argue to reduce this number; my point in this article is that the negativity on Intel is overdone. But I'm not blind to the threat of competition and the possibility of Intel's moat disappearing, and because of that, I have limited the projection of Intel's earnings growing to just five years into the future. Then I discounted against an investment in the S&P 500. If you think those assumptions are reasonable, you will be interested to find that the result is that a share of Intel is actually worth about $28.
That means Intel at $22 has 28% room to run. A nice margin of safety to acquire a wide moat company.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.