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At the end of last year, I picked Intel (Nasdaq: INTC ) as my best stock for 2010. Good thing I wasn't holding my breath for a breakout, because the stock has actually underperformed the market so far this year.
Not that I expected the chip champ to have some crazy bull run during the year and make investors rich: After all, it's a huge company with more than $40 billion in revenue. But in terms of high-quality companies that can be bought at attractive prices, I think Intel has to be very high up on the list.
But just how attractive is Intel's price? Well, let's take a look to see if this tech giant really is a bargain.
It's a beautiful day in the neighborhood
One way to get an idea of what a stock might be worth is to check out how other comparable semiconductor and high-technology companies are valued. So let's take a look at how Intel stacks up.
Price / Forward Earnings
Total Enterprise Value / Trailing Revenue
Price / Book Value
|Broadcom (Nasdaq: BRCM )||14.9||2.7||4.2||0.8|
|Cisco Systems (Nasdaq: CSCO )||13.4||2.6||2.9||1.1|
|Maxim Integrated Products (Nasdaq: MXIM )||13.5||2.8||2.8||1.1|
|National Semiconductor (NYSE: NSM )||10.5||2.3||6.5||1.4|
|NVIDIA (Nasdaq: NVDA )||20||1.4||2.5||1.4|
|Texas Instruments (NYSE: TXN )||11.9||2.4||3.5||1.1|
Source: Capital IQ, a Standard & Poor's company, and Yahoo! Finance.
Average excludes Intel.
Using each of those averages to back into a stock price for Intel, and then taking the average across those results, we can come up with an estimated price per share a few pennies shy of $25.50. This would suggest today's price of right around $20.50 is notably undervalued.
A comparable company analysis like this can sometimes raise as many questions as it answers, though. For instance, is the entire group properly valued? A supposedly fairly valued -- or even overvalued -- stock among a bunch of other undervalued stocks may actually be an undervalued stock, and vice versa.
Also, while these companies are comparable, they're certainly not all the same. National Semiconductor and Maxim, for instance, are also chip companies, but the analog and mixed-signal chips that they produce aren't the same as the digital chips that Intel focuses on. While Cisco is a fellow tech titan, its communications equipment business is very different than Intel's. And unfortunately, Advanced Micro Devices (NYSE: AMD ) , the company with the most comparable business to Intel, has had such wonky financials recently that drawing valuation comparisons would be relatively meaningless.
So with all that in mind, it's best to combine comparable company analysis with another valuation technique.
Collecting the cash flow
An alternative way to value a stock is to do what's known as discounted cash flow (DCF). Basically, this method projects free cash flow over the next 10 years and discounts the tally from each of those years back to what it would be worth today (because a dollar tomorrow is worth less to us than a dollar today).
Because a DCF is based largely on estimates (aka guesses) and it tries to predict the future, it can be a fickle beast, so its results are best used as guideposts rather than written-in-stone answers.
For Intel's DCF, I used the following assumptions:
|2010 Unlevered Free Cash Flow||$10 billion|
|FCF Growth 2010-2014||3%|
|FCF Growth 2014-2019||3%|
|Market Equity as a Percentage of Total Capitalization*||98%|
|Cost of Equity||12%|
|Cost of Debt||3.3%|
|Weighted Average Cost of Capital||11.8%|
Source: Capital IQ, a Standard & Poor's company; Yahoo! Finance; author's estimates.
*The percent of the company's public equity compared with its total value including debt.
While most of this is pretty standard fare when it comes to DCFs, the academically inclined would probably balk at the way I set the cost of equity. In a "classic" DCF, the cost of equity is set based on an equation that uses beta -- a measure of how volatile a stock is versus the rest of the market -- and a few other numbers that I tend to thumb my nose at.
But when you get right down to it, the cost of equity is the rate of return that investors demand to invest in the equity of that company. So I generally set the cost of equity equal to the rate of return that I'd like to see from that stock.
As for Intel's growth, it may jump out that the 3% I've used is well short of the 12.3% that analysts seem to be projecting. In fact, I think that much of that expected growth rate comes from the huge jump in Intel's bottom line this year. Looking ahead, I think investors should probably count on pretty sluggish organic growth out of Intel.
Based on the assumptions above, a simple DCF model spits out a per-share value of just north of $25 for Intel's stock. This seems to confirm that the stock is undervalued.
Do we have a winner?
The valuations that we've done here are pretty simple and, particularly when it comes to the DCF, investors would be well advised to play with the numbers further before making a final decision on Intel's stock.
That said, pegging the price right between the two valuation models at $25.25, I feel comfortable saying that Intel's shares are a very worthwhile pickup right now. And because valuation alone is rarely reason enough to buy a stock, I'll throw in there that this is one of the world's premier tech companies and it also pays a not-too-shabby 3.1% dividend.
I've got my money where my mouth is on this one: Intel is one of the largest holdings in my personal portfolio. But I want to know what you think. Are Intel's shares really undervalued? Or am I out of my cotton-pickin' mind? Head down to the comments section and sound off.
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