Monday, December 17, 2012

The No. 1 Reason Intel Is A Buy

Intel (INTC) is a large cap semiconductor manufacturer with 100,000 employees. In the last year it had 54 billion in revenues, and 12.5 billion in profits.

It's not hard to find commentators bearish on Intel. The standard line is that they missed the boat on mobile, and low powered chips. Now, wedded to big iron, they are a dinosaur in decline. That makes a nice storyline, but does it agree with the facts? Well, if ARM and the like were eating Intel's lunch, the first place it would show up is in a sales decline. Here is Intel's sales for the last ten years.

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INTC Revenues TTM data by YCharts

No slowdown here. In fact, Intel's TTM revenues just hit an all time high. Ok, well then how about gross margins? Surely all this competition should be compressing Intel's margins.

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INTC Gross Profit Margin data by YCharts

Nope. Gross margins are near new ten year highs at 63%. Profits?

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INTC Net Income TTM data by YCharts

Ditto. Near new all time highs. If this is what decline looks like, I'll take a double portion please. Finally, let's take a look at what owning a slice of this cash generating monster will cost you:

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INTC PE Ratio data by YCharts

The stock is now trading at about the lowest price to earnings ratio of the last ten years. At less than 12 times trailing earnings, Intel is solidly in bargain basement territory.

As great as all these data points are, the best reason for owning Intel is not their geyser of earnings or low valuation. Those are great, but what really sets Intel apart from most publicly listed companies is what they do with their earnings. They give it back to shareholders. A radical idea, I know. You would think that this would be more common, but it really isn't. The media gets all excited every time earnings season rolls around, and reports that company X made this and company Y made that, but that's just the first step in creating value for shareholders. The next is taking that money and getting it to shareholders. Warren Buffett has hammered on this point again and again over the years (if you have not read his annual reports here, you really should).

The fact is that if your company makes a dollar, you as the shareholder are unlikely to ever see more than a small fraction of that. I know, I know, companies have to reinvest to keep the business going, but all too often prior earnings are frittered away on ill conceived acquisitions or stock grants (where the company buys stock back and then hands it out to employees in option grants). So just how shareholder friendly has Intel been? Very.

To get an idea of how responsible a company is with shareholder money, I like to do a simple cash flow analysis over the past 10 years. This allows plenty of time for earnings to make their way into shareholder pockets. Just follow the money.

Over the past 10 years Intel has reported aggregate earnings of 71 billion. Over that time they paid out 22.5 billion in dividends, and reduced the number of shares outstanding by 1.45 billion at a current value of about 40 billion (they actually spent 46.5 billion buying shares, but they only get credit for the value of retired shares).

Dividing the money that went to shareholders (62.5 billion) by the money that was earned (71 billion) gets us what I call the Earnings Conversion ratio. In Intel's case it's 88%, which is fantastic, and the kind of figure you are more likely to find in a shareholder friendly cash machine like Philip Morris than a tech company. As a final check, I look at tangible book value to make sure that the company isn't using debt to finance distributions. Intel isn't. Tangible book is slightly higher now than it was ten years ago.

So, not only does Intel make buckets of cash, but their buckets don't leak, allowing shareholders to get the full benefit of all that earning power. That's rare - even more rare than Intel's terrific earning power, great margins, and current low valuation -- and that makes it my number one reason that Intel is a great stock to own.

I would be curious how important profit conversion is to the Seeking Alpha community when you are making investment decisions. Does anyone have another metric they like to use to illuminate how much of a company's earnings reach shareholders?

Disclosure: I am long INTC.

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