Why We're Buying Our Favorite Dividend Stock

Investing is difficult, but it doesn't always have to be so. When a fat pitch comes straight down the middle of the plate, it makes sense to swing at it. And we believe we're seeing a fat pitch right now with Intel (Nasdaq: INTC  ) .

It's hard to believe that Intel -- with its outstanding management team and promising future -- would be trading at such an attractive price. But that's the reality and we're not complaining. Instead, we're buying shares of the company for our real-money 10-Bagger Portfolio. Intel, of course, is unlikely to become a 10-bagger from here, but we do feel it has the potential to generate 15% (or higher) annual returns over the next five years.

What makes Intel tick?

If you're using a computer, chances are there's an Intel component inside. Intel has been a leading microprocessor manufacturer for many, many years and remains the market-share leader in many categories today. Below is the breakdown of its main business segments by market share:

PC Segment

Market Share

Desktop 73.8%
Mobile (laptops) 83.8%
PC server/workstation 94.5%
Smartphones and tablets <5.0%

Sources: IDC and CNN Money.

And here is some additional financial information for the last three years:

Revenues

2009

2010

2011

PC Client Group $24,894 $30,327 $35,406
Data Center Group $6,450 $8,693 $10,129
Other Intel Architecture Operating Segments $2,683 $3,055 $5,005
Operating Profit Before Tax
2009
2010
2011
PC Client Group $7,441 $12,971 $14,793
Data Center Group $2,289 $4,388 $5,100
Other Intel Architecture Operating Segments ($45) $270 ($577)

Source: S&P Capital IQ. All figures in millions.

Intel uses what it calls its "Tick-Tock" strategy to stay in front of its main competitor, Advanced Micro Devices (NYSE: AMD  ) . AMD holds 26% of the desktop processor market, 16% of the laptop processor market, and only 5.5% of server processors. "Tick-Tock" refers to the rhythm of Intel's product development cycle. The company updates its production technologies to manufacture next-generation chips and then leverages those capabilities to develop new chip architectures. So the company is constantly innovating in order to drive technology forward and stay ahead of the competition.

The personal and server computing markets are healthy but mature. In contrast, smartphone and tablet adoption rates are some of the fastest in history. And looking at the table above, Intel is hardly a player yet in this area. ARM Holdings' (Nasdaq: ARMH  ) designs are in 95% of those devices today. Intel wants to change that, of course. To do so, the company is trying to focus on providing chips with energy-efficient processing, connectivity, and improved security.

It's going to be a tough battle, but Intel believes it has a really big weapon that few can use: its own foundries. ARM Holdings, unlike Intel, doesn't manufacture its own chips. It licenses the designs to companies like Qualcomm (Nasdaq: QCOM  ) and NVIDIA (Nasdaq: NVDA  ) . By controlling the design and fabrication of its chips, Intel can continue to drive chips to smaller form factors, while maintaining processing power and reducing power consumption. That's the plan with its Atom system on a chip platform known as Medfield as it goes after the smartphone and tablet markets.

A strong captain and crew
Since taking over in 2005, CEO Paul Otellini has done a great job of managing the company. Not only has he guided Intel through the ever-changing technology landscape, but he's also transitioned the company from a fast-growth to a mature-growth phase.

Otellini joined Intel in 1974 and has held positions throughout the company during his tenure. In 2006, he restructured the company to prepare it for the future. Thus far, the company has continued to grow both organically and through acquisition since the beginning of his tenure as CEO.

Today, Otellini has his sights set clearly on the smartphone and tablet markets. They are growing significantly faster than the PC and server markets, and up to now, Intel has not been a meaningful presence in this area. Otellini intends to change that, and thinks the continued development of the Medfield chip is the way to do it.

Hidden right before our eyes
We think Intel is positioned well for the future. It is a leader in processors for PCs and servers and Otellini has a compelling plan to capture a good portion of the smartphone and tablet markets. We're pretty confident that Intel will continue to use its competitive advantage to generate increasing cash flows and solid returns on invested capital.

The question is not so much "What is Intel worth today?" but rather, "What can Intel deliver tomorrow?" Is there significant value here over the long term?

In our opinion, the answer to those questions lies in the following numbers. Intel currently pays a dividend that yields 3.4%. Over the past three years, the dividend has averaged 12% growth. What's more, the company spent over $27 billion reducing its share count by over 10% in the past five years.

We think that if the company were to keep up that pace, it could very easily return 15% in total annualized returns over the next five years or so. Remember, this company is a market leader with a solid balance sheet and management team that looks out for shareholders. Add it all up and you could get yourself a double over the next five years without taking on too much risk.

It's time for the happy zone
The legendary baseball great Ted Williams divided up his strike zone into smaller zones, and then computed his likely average for each of those areas. Ultimately, he tried to swing in the most promising area, which he called his "happy zone."

Intel is in our happy zone, and we're taking a swing at it. It possesses many of the qualities we look for in a company. It's a leader with a talented management team and the potential to generate rock-solid returns. And we think it adds some nice balance to our portfolio too.

There's a lot of uncertainty in markets right now, so looking for dividend-paying stocks is a very wise strategy, even for growth investors like ourselves. The Motley Fool's top analysts have put together a free report titled "Secure Your Future With 9 Rock-Solid Dividend Stocks." If you'd like to learn more about these outstanding companies, you can grab your free report today.

John Reeves and David Meier do not own any shares mentioned in the article. You can follow both John and Dave on Twitter: @TenBaggers.

The Motley Fool owns shares of Qualcomm and Intel. Motley Fool newsletter services have recommended buying shares of NVIDIA and Intel. Motley Fool newsletter services have recommended writing puts on NVIDIA. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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