By Mark Bern, CPA CFA
I remember buying both Cisco (CSCO) and Intel (INTC) in the late 1990s even though the valuation made no sense. Back in the days of the Internet bubble it was all about momentum, building a brand and capturing the most “hits." Cisco and Intel were enablers of the craze and were growing at phenomenal rates. But even then the multiples were neither supportable nor sustainable from a fundamental point of view. Then, in March 2000, I told my wife that I just could not justify continuing to own these gems much longer. Unfortunately, I did not heed my own advice immediately and held for several months longer as the bubble began to burst. I made some money but watched with horror as much of my gains evaporated.
Today, these tech behemoths are still around, unlike many of the other beneficiaries of the Internet’s decade-long rise to prominence. Cisco still benefits largely from growth in Internet usage and so does Intel, but in a less direct fashion. Back then one wanted to own both companies for the sheer growth potential. Now, I want to suggest that owning one or the other is more appropriate for most diversified, growth and income focused portfolios.
If, as an investor, one is more focused on a rising dividend, then Intel seems to be the better choice. Cisco has a very limited record in this department (began paying dividend in 2011), while Intel has paid a dividend since 1992 and has raised its dividend for eight consecutive years (the dividend remained flat for three years after the Internet bubble burst from 2001-2003 but has risen every year since).
In recent news Intel reported earnings for the September quarter that represented an increase of 25% over the same quarter in the prior year. Most of the growth was attributed to double-digit growth in notebook computers as well as strength from mobile and cloud computing which drove data center demand. These results represented a positive surprise compared to street expectations.
Cisco reported a decent quarter but did not record growth as robust as Intel. Revenues were up more than consensus at 5%, year-over-year. Earnings were about in line with expectations. The biggest positive was that the company posted a sequential revenue increase during a quarter that is traditionally prone to weakness. The other positive takeaway is that orders were generally running higher (up over the prior year by low teens). Again on the negative side of the page was a decrease in its gross margin by 2.7%, down from 64% to 61.3.
Let’s compare the companies by the numbers. I’ll start with the balance sheet. Since the companies do not belong to the same industry, I will not compare them to an industry average. Cisco’s debt has been rising fairly consistently but the one thing that alarms me a bit is the rate of increase: up 33.2% in the last year. This has resulted in an accompanying increase in the company’s debt to equity ratio to 34%. Intel has been able to fund its growth internally from cash flows and thus sports a debt to equity ratio of just 4%. Book value has increased at a similar clip for both companies, rising 18.8% and 17.2% in 2010 for Intel and Cisco, respectively. Capital spending has risen faster at Intel than at Cisco at 14.6% in 2010 compared to 5.9%. The estimated increase for 2011 also favors Intel but by a much wider margin. Intel is reinvesting more in its business without increase debt. The balance sheet favors Intel.
Now we’ll look at the income statement. Revenues look to be growing at nearly 24% for Intel, for the full year 2011, and nearly the same pace as last year. At Cisco revenue is growing at about an 8% clip this year compared to 10.9% in 2010. Operating margins at Cisco have weakened slightly in 2011 compared to 2010 to about 23.5% while at Intel the operating margin looks like it will come in near 48%, about 200 basis points higher than in 2010.
Earnings will likely be down at Cisco by around 12% compared to 2010. It appears that Intel’s full year 2011 earnings should increase by over 14% in 2011 compared to the prior year. The profit margin at Cisco is headed down in 2011 compared to 2010 by over 20% while at Intel the profit margin has dropped by 16%. It should be noted here that the profit margin at Cisco in 2010 was near its normal level at 19.4% while Intel had a stellar year having increased its profit margin to 26.8% in 2010. The 16% drop at Intel merely brought the profit margin down between 22% and 23% which is still above average for the company. I have to give Intel the nod here also.
I mentioned the difference in dividend records above so I’ll merely point out that Intel yields 3.4% while Cisco’s yield is only .6%. However, Cisco still has the lower payout ratio at only 10%. Intel’s payout ratio is a reasonable and sustainable 33%.
The interesting thing about comparing these two dominant companies is that Cisco has been afforded by the market the higher price to earnings ratio of 16.5 relative to Intel at 10.2. Cisco is close to its fair value on this basis while Intel, which historically sports a PE closer to 20, is trading at a deep discount both to Cisco and to its historic levels. Since Intel seems to be operating on all cylinders and has surprised with positive earnings for several quarters I would expect the market to remedy this imbalance over the coming months and years.
My five-year projected targets for the two companies are: Intel, $55; Cisco $27.50. The clear winner between these two companies is Intel for both appreciation potential and rising dividends with a higher yield.