Intel: A Stock For All Seasons

| About: Intel Corporation (INTC)

In an increas­ingly chal­leng­ing mar­ket, Intel (NASDAQ:INTC) is one of the safest invest­ments with com­pelling upside poten­tial. That’s right, investors get to have their cake and eat it too – at least for now.

As one of January’s Most Attrac­tive stocks, INTC offers the rare com­bi­na­tion of strong cash flow growth with a remark­ably cheap val­u­a­tion. Investors were rewarded hand­somely over the last 9 months after I rec­om­mended buy­ing the stock at under $21 (see “Too Cheap To Pass Up”).

First, on the safety of invest­ing in INTC: with return on its invested cap­i­tal (NASDAQ:ROIC) at 32%, Intel has one of the strongest busi­ness mod­els in the busi­ness. The com­pany gen­er­ates very strong eco­nomic earn­ings. So much, in fact, that the com­pany can afford to pay a gen­er­ous div­i­dend (3.3% yield) while also build­ing cash reserves ($20 bil­lion) and mak­ing strate­gic invest­ments such as Infi­neon Tech­nolo­gies (OTCQX:IFNNY), maker of the chips inside the iPhone 3GS.

This strong per­for­mance under­scores the strength of INTC’s busi­ness and the abil­ity of its man­age­ment team to allo­cate cap­i­tal intel­li­gently. They have made mis­takes along the way, even some­what recently with the recall of its “Core i7” chip. How­ever, mis­takes for INTC are the excep­tion not the rule. Over the last thir­teen years, INTC has gen­er­ated pos­i­tive eco­nomic earn­ings every year except for two, an accom­plish­ment matched by only a hand­ful of com­pa­nies in the world.

INTC is and will con­tinue to be one of the strongest and best-positioned com­pa­nies in the high-growth-potential semi-conductor sector.

Sec­ond on the upside poten­tial, the value of the stock assum­ing no future profit growth is $28.50. In other words, the cur­rent stock price, $25.14 as of close on 1/13, implies the company’s prof­its will per­ma­nently decline by 10%. Those are some very low expec­ta­tions, which means down­side poten­tial in the stock is lim­ited com­pared to upside potential.

Bears will argue that sup­ply dis­rup­tions will hurt Intel’s earn­ings. To which I reply, it is true that short-term earn­ings may suf­fer because of flood­ing in Thai­land. How­ever, as long as the sup­ply dis­rup­tion is tem­po­rary as it appears to be, the long-term cash flows of the stock are not dimin­ished. As long as there is demand for INTC’s prod­ucts, the cash flows will be there.

The con­tin­ued pro­lif­er­a­tion of elec­tronic devices is a strong indi­ca­tion that demand for semi-conductors and proces­sors remains strong. Though a severe global eco­nomic slow­down could dent the val­u­a­tions of nearly all assets, I would still expect INTC to be a top per­former given the steady nature of its cash flows and the fact that demand for elec­tron­ics is likely to hold up. Elec­tron­ics and proces­sors are increas­ingly embed­ded in more and more things, even our toast­ers can talk to us now.

The tech­ni­cian will point to INTC trad­ing near the top of a long-term trad­ing range and bounc­ing off a long-term resis­tance level. To which I reply, this is not a momen­tum story. My the­sis is based on the firmer ground of fun­da­men­tal analy­sis of cash flows and val­u­a­tion. I pre­fer not to rely on the past to pre­dict the future.

If you intend to be an investor, as dis­tinct from a spec­u­la­tor, then there is only one, true way to out-perform over time and that is with supe­rior fun­da­men­tal research.

For investors wary of invest­ing in any sin­gle stock, I rec­om­mend the fol­low­ing ETFs because they have the largest allo­ca­tions to INTC and get my “attrac­tive” fund rat­ing:

  1. ProShares Ultra Semi­con­duc­tors (NYSEARCA:USD) allo­cates 37% to INTC
  2. Mar­ket Vec­tors Semi­con­duc­tor ETF (NYSEARCA:SMH) allo­cates 20% to INTC

Note there are no mutual funds that get an “attractive”-or-better rat­ing and make large allo­ca­tions to INTC. The mutual fund that makes the largest allo­ca­tion (12%) to INTC is the Rydex Series Funds: Elec­tron­ics Fund [RYSIX] gets my “dan­ger­ous” rat­ing based on hold­ings as of 11/30/11. The next largest allo­ca­tion by a mutual fund is 9% for the Invesco Van Kam­pen Exchange Fund [ACEHX], which gets my “neu­tral” rat­ing based on hold­ings as of 10/31/11.

These funds do not earn “attrac­tive” or bet­ter rat­ings despite their large allo­ca­tions to INTC because they allo­cate too much of the rest of their port­fo­lios to “neutral”-or-worse rated stocks. RYSIX also hap­pens to have very high costs at 5.5% annu­al­ized over three years, which war­rants our “very dan­ger­ous” rat­ing for Total Annual Costs. More details are in my RYSIX report and my ACEHX report, which are here.

Disclosure: I am long INTC.