It dominates the industry for microprocessors. It has a rock solid balance sheet, hasn't lost money in any year on memory, and has been shoveling money at shareholders for a decade. The stock trades at 10.5 times trailing earnings after adjusting for net cash. So isn't Intel (INTC) a bargain, even relative to a bunch of other big, reasonably priced technology companies like Microsoft (MSFT), Cisco (CSCO), HP (HPQ) and Dell (DELL)?
We certainly thought so when we looked at the stock in early 2006. Shares traded hands around $21 at the time. Adjusted for net cash, the stock was at less than a 13x multiple to 2005 earnings. The market at the time was pricier than it is now -- the S&P's level has risen only 6.9% in the five years since -- so the giant looked like a relative and absolute bargain. It appeared the cheapest it had ever been. We bought the stock.
But 2005 ended up being the high water mark for Intel for a while. EPS dropped nearly 40% in 2006 as pricing pressures hurt profits. Shares closed 2006 19% below the 2005 close, trailing the market by 30% in 2006. Most of this drop happened after disappointing 1Q guidance, but the holding still cost us in 2006 in what was otherwise a solid year.
It turned out that while Intel is the industry leader and thus enjoys supernormal returns on invested capital, results are still cyclical to some degree. While 2005 earnings were $1.40, they were a cyclical high and shouldn't have been relied upon as normal. Here's Intel's earnings history over the past 10 years:
That's some pretty significant variance. It was a volatile decade, with Intel suffering from weak end demand after the tech bubble burst and following the 2001-'02 recession, and during the '07-'08 financial crisis.
So we figured any one year isn't representative. We're not going to pretend that we came up with this on our own: Ben Graham insisted on looking at earnings over a period of time to avoid overpaying based on peak cycle earnings. Below are Intel's earnings by year, but based on the prior 5 year average:
That looks really steady. In fact, Intel's worst decline during the period was a 6.4% fall in 2009, after two lean years during the U.S. recession. This method, of course, smooths results. But we think it gives a good approximation of earning power.
So that 13x multiple (adjusted for net cash) we thought we were paying in early 2006? Based on average earnings, we were actually paying a whopping 23x! Hardly a bargain -- even for Intel.
In fact, nowadays shares trade for 17x the 5 year average, after adjusting for Intel's net cash. One might make the argument that Intel deserves 20x, but shares certainly don't look like a screaming bargain. Will earnings remain at the current plateau? Has something changed -- besides Intel's purchase of less cyclical McAfee -- or has Intel's business grown significantly? Our crystal ball is presently hazy (in fact, it's always hazy) so it's anyone's guess.
Analysts historically have had little idea on January 1 what Intel will earn through Dec 31. At present they are guessing Intel's earnings will be about the same as 2011. Given the history, that's unlikely. Investors would probably be well served by being cautious.
Disclosure: I am long INTC.