This Just In: Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

And speaking of the worst...
I've got good news and bad news for Intel (Nasdaq: INTC  ) investors today. Good news first, you say? No problem.

Yesterday, a Wall Street analyst came out with a spirited defense of the semiconductor star. Even if the volume of total personal computer sales is on the wane, argues the analyst, a combination of market-share gains in PCs, greater server sales, cost savings on Sandy Bridge chips, and hikes in average sales price will keep profits growing. The analyst endorsed Intel's Ultrabook initiative as a viable solution to the problem of tablet computers stealing away PC market share, and further predicted that Intel's upcoming Romley processor for servers, as well as the new 3-D Ivy Bridge chip, will ensure Intel's dominance for years to come.

Sound good? It gets better. Right now, Cisco (Nasdaq: CSCO  ) , salesforce.com (NYSE: CRM  ) , and Amazon.com (Nasdaq: AMZN  ) are making huge investments in "cloud computing." (Indeed, part of the reason for Amazon's big earnings miss last quarter was ascribed to investments in its cloud computing program.) And what are these companies "investing" all their money in? Servers. According to this analyst, capital spending on server farms will need to rise as much as 49% in 2012 to keep up with the pace of growth. This is an acceleration from the 32% pace set in 2011, and promises to take up much of the slack that Intel might otherwise suffer from weak PC sales.

All of which adds up to a strong buy argument for Intel, which should "remain dominant in the mainstream with Romley" even as its Ultrabook initiative promises to "counter the ARM [ (Nasdaq: ARMH  ) ] threat."

But now for that bad news: The analyst making all of these glowing predictions for Intel was Maxim Group -- one of the worst analysts on Wall Street, by our tracking.

How bad is it?
Just how bad of an analyst is Maxim Group? Sad to say, this analyst scores in the lowest quintile of investors tracked on CAPS. Fifty-nine percent of its recommendations fail to beat the market, actually averaging a 5.6-percentage-point loss per pick. And adding injury to insult, Maxim has shown itself to be roughly four times more likely to be wrong than right when recommending semiconductor stocks.

All of which suggests that Maxim might be making the wrong call on Intel, too.

The case against Intel
I admit that at first glance, there's a strong buy case to make for Intel. At 11.2 times earnings, the stock doesn't look particularly expensive for the 11.6% long-term growth it's expected to produce. Moreover, Intel boasts a sizable cash hoard of $7.5 billion, and pays a generous 3.1% dividend. All points in Intel's favor, to be sure.

But consider the contrarian case. You see, Cisco, Salesforce, and Amazon aren't the only companies investing heavily in the cloud computing future. Intel's having to make hefty cash layouts as well, as it plays catch-up in mobile computing and tries to capitalize on the promise of the cloud. Last year, the company spent $10.8 billion on capital investments, and an additional $8.7 billion on acquisitions. Even if you don't count the latter expense against free cash flow, Intel's FCF number for the year still came in 21% below reported income.

And it gets worse. According to Intel, revenues this year are going to rise in the healthy "high single digits." Well and good. But capital investments, according to management, will run nearly twice as fast, up an estimated 16% (and perhaps more) versus 2011's already high levels. What this means is that even if revenues go up, it's entirely possible that free cash flow will take another hit in 2012. It could again fall short of reported net income, and push Intel's valuation past its already high level of 13.3 times free cash.

Foolish takeaway
The case against Intel is not strong enough to demand that you short the stock. I don't intend to, myself. But it's not nearly as one-sided as the bull argument Maxim Group makes.

Not interested in gambling on a turnaround in the topsy-turvy semiconductor market? Can't say I blame you. Perhaps we could interest you in a few rock-solid dividend stocks instead? Read our (free) Fool report today -- but act quickly. It won't be available at this price forever.

Fool contributor Rich Smith does not own (or short) any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 360 out of more than 180,000 members. The Motley Fool has a disclosure policy.

The Motley Fool owns shares of Amazon.com, Cisco Systems, and Intel. Motley Fool newsletter services have recommended buying shares of Amazon.com, salesforce.com, Intel, and Cisco Systems, while another Fool newsletter service has recommended shorting salesforce.com.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.


Read/Post Comments (2) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 07, 2012, at 11:23 PM, jdwelch62 wrote:

    Hello. Here we go...

    1) I think your argument "for" Intel is a lot stronger than your argument "against" Intel.

    2) I wouldn't dismiss the message just because you dislike the messanger (Maxim Group). By your own admission, they're right 41% of the time.

    3) In 2000, Intel was just getting started as a player in the server space. According to your Foolish associate Alex Planes, "Intel's x86 architecture (which includes AMD designs) didn't pass the market-share halfway point until near the end of 2004, and AMD commanded a quarter of the x86 server market as late as 2006". Now, 6 years later, Intel owns over 95% of the server market. Your article says that "capital spending on server farms will need to rise as much as 49% in 2012 to keep up with the pace of [cloud computing] growth". Server chips are more expensive and have higher margins than other PC chips. I think this bodes very well for Intel.

    4) In case you weren't aware of it, Rich, the semiconductor manufacturing business is very, very capital-intensive. It costs upwards of $5Billion or more to build a Fab, which is one of the reasons Intel is one of the few remaining companies in the world that build, own and operate Fabs. So, yes, they're going to be spending a lot on capex to stay ahead of the pack. But revenues at EOY2011 increased by over $10Billion, so it stands to reason that capex in 2012 will keep pace as Intel continues to invest in its own (and your) future. By that I mean, they're spending what they've earned, and have very little debt. They have a long record of increasing dividends, pay a healthy 3.1% dividend, and a payout ratio of only 33%.

    5) Intel's silicon is at least 2 generations ahead of the nearest competition, and about to get further ahead.

    6) To paraphrase yourself, the case against Intel is not nearly as one-sided as the bear argument you try to make in the second half of your article.

    I am long INTC. I'll check back with you in a year to compare notes...

    Fool on!... :-)

  • Report this Comment On February 08, 2012, at 11:58 AM, TMFDitty wrote:

    Not sure why you're defending an analyst whose record for accuracy is 10 points shy of your own ... but okay. Points noted. We'll check back in a year.

    TMFDitty

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