Drip
Portfolio Report
Wednesday, December 17, 1997
by Jeff Fischer
([email protected])
ALEXANDRIA, VA (Dec. 17, 1997) -- With 42% of sales and 68% of operating income coming from Asia in 1996, the probability of Intel (Nasdaq: INTC) seeing downward earnings pressure from the Asia malaise is high. Add to that the fallout in the disk drive market and the concerns regarding inexpensive thin-client computers, and we have investors who are rightly or wrongly worried about Intel's near-term earnings power. Meanwhile, Intel has been slashing prices on its Pentium chips in order to maintain its monstrous lead over the competition.
Intel's primary competition comes from Advanced Micro Devices (NYSE: AMD) and Cyrix (Nasdaq: CYRX), though the competition isn't very daunting. Advanced Micro Devices has been over-hyped as a possible Intel killer, when in fact the company sold only $300 million worth of microprocessors in 1996. AMD increased sales with its K6 chip this year, but only at a loss because Intel has continuously slashed prices on its own chips. AMD's K5 chip was about one year late, and the K6 chip has not yet been produced in quantities that are hoped for, in part because the yield that the company has achieved from its new fabrication plant has been disappointing. With only $440 million in cash (compared to Intel's nearly $9 billion in cash), the company is facing an uphill battle in a capital-intensive industry. The stock performance has mirrored that battle, with AMD returning less than 4.5% annualized over the past five years.
Intel recently divided its business into three divisions to serve the three segments of the computer industry, while AMD is still struggling to get production of its flagship chip at an acceptable level. Meanwhile, the prospect of AMD actually turning a profit declines with every price cut that Intel makes -- and can afford to make. Intel's initiative of pushing gross margins lower isn't without purpose: the company wants to make the latest computing technology available to everyone, thereby fostering growth of the PC industry in other arenas as well. The company is involved in networking, videoconferencing, and memory technology, to name a few key areas.
As great a company as Intel is -- and with as much market dominance as it possesses -- we wouldn't be surprised to see it miss earnings estimates again when it announces fourth quarter numbers during the second week of January. The company is expected to earn $0.90 per share, 16% below what it earned in the same quarter of last year. For the year that ends in December, Intel is expected to increase earnings 30% to $3.79 per share. Even if Intel misses earnings estimates by more than a few cents next quarter, it will still grow earnings per share over 25% this year. But for 1998 analysts have continued to knock estimates lower, and they now expect earnings to grow only 9% to $4.13 per share.
Why?
Price-cutting and demand are the primary factors, with Asia included in the demand scheme of things (and currency factors included in that). There is little more to consider right now. The price-cutting has a purpose, while demand is difficult to predict and is going to be cyclical -- or at least fluctuate. That's that. Fluctuating demand is a given.
This is why we're not overly concerned about Intel, even as the stock continues to slide. Plus, we'd rather have our stocks hold steady or go down as we begin to invest in them, as long as we believe that we're getting value for each dollar initially invested (meaning that we can bank on a decent compounded return on every invested dollar in the end). This is better than having our positions soar, causing us to chase them. For some this statement has been read as a mixed message, and they ask, "Then why not buy Coca-Cola and just hope that it doesn't go anywhere or goes down for the next several years?"
First, we wouldn't believe that we'd be getting good current value for our dollar, and that often results in market underperformance. Second, we do feel that we're buying Intel and Johnson & Johnson at reasonable prices, which means a lot when you're beginning to build an investment base. And third, we can't buy anything that we see as overpriced with the blind hope that the stock will decline to a more reasonable valuation in the future. In that scenario, we could buy Coca-Cola for four years before the stock finally began to contract to a lower valuation, resulting in four years of wasted dollar-cost averaging at higher prices. Or, the stock could go nowhere for four years, and then appreciate 10%, still giving a miserable annualized performance.
Once we do find value, however, and begin investing in it, we don't mind so much if that position declines as we continue to invest, because even our first investment in these cases -- an investment made at higher prices -- should bear us fruit at least in the intermediate term. If you begin by investing in good value, it's much more difficult to go wrong as you continue to invest if the business remains relatively unchanged.
If this isn't clear or doesn't make sense, please post questions or flames on the message board and we'll talk about it more there.
We bought our fist share of Intel at $94, or 22 times the current earnings estimate for 1998. That price represented a slight premium to the S&P, which is trading above 20 times earnings estimates. Our average cost on Intel is now about $81, or 19 times 1998 estimates. With the stock now at $69 1/2, we'd be buying more shares at 16.8 times earnings estimates. And I could easily see Intel going down to 13 or 14 times estimates if there is more uncertainty or an industry slowdown -- and we'd be happy to buy there.
Let's consider our current cost basis of $81 and slap some earnings growth on the number. If Intel can grow earnings per share just 9% annually for the next five years, the company would earn $5.68 per share in the year ending five years from now, and our current cost of $81 is at 14 times that estimate. Intel is expected to grow earnings at over twice that rate, though. Let's give Intel 15% growth, 5 points below analysts' estimates of 20% annually. At 15% we have $7.03 in earnings per share in less than five years, and our cost basis is priced at 11 times that estimate. We can probably get our cost basis much lower than $81 if the stock's weakness continues and if we keep investing. At $70 the stock is priced at 9 times estimates five years out if Intel grows 15% per annum. This valuation presents the distinct possibility of a double in the stock price over five years, if Intel can again trade at 18 times trailing earnings in a future market.
The S&P, historically growing at 10.7% per year, doubles every seven and a half years. We'd be well ahead of the S&P if the return on our cost-basis in Intel could double in five years -- not including reinvested dividends.
For fun, let's finally consider the analysts' (high, in my opinion) estimate that Intel can grow 20% per year for the next five years. (Hey, we'd love if Intel could pull this off -- and perhaps it can.) At that rate of growth, Intel would earn $8.56 per share in five years, and our $81 cost basis trades at 9 times that estimate, while the stock at $69 1/2 trades at 8 times the estimate. If the company is growing 20% annually, it would almost certainly demand a trailing P/E closer to 20 -- say 18 -- and we then have our double even from the current cost basis of $81.
This is speculation, but it isn't outrageous speculation. I'd rather continue to look at the business in-depth than try to guess what earnings growth will be for five years, especially because earnings growth perceptions can change every quarter. But this type of study does have merit, of course. We can fairly safely surmise that dollar-cost averaging into the stock now isn't putting money on the line -- at all. The stock could go lower, but over five years time, any money that we invest now should give us an ample return given respectable market-beating (11%) earnings growth at Intel Corp.
To the DRP investor who sends money every month, regularly and without thought -- more power to you.
Finally, Johnson & Johnson (NYSE: JNJ) rose just shy of a new high today, to $66 7/16. The high was $66 1/2 hit in mid-June. We don't want to keep throwing all of our monthly savings to one investment, so Johnson & Johnson will enter the regular investing scene for us very soon, too, now that we're enrolled in the DRP plan.
Tomorrow we'll consider Quaker Oats (NYSE: OAT).
Fool on!
--Jeff
Do your Foolish gift shopping now, in time for the Holidays. And consider the Fool's Industry Focus '98 book -- to learn not only about industry-leading stocks, but about the industries in which they operate as a whole -- and see which one company in each industry that our news and analysis team favors most.
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TODAY'S NUMBERS
Day Month Year History Drip (1.03%) (5.13%) (15.22%) (15.22%) S&P 500 (0.26%) 1.06% 30.35% 1.49% Nasdaq (0.36%) (3.32%) 19.86% (2.91%) Last Rec'd Total # Security In At Current 12/01/97 6.082 INTC $81.346 $69.500 11/14/97 1.000 JNJ $62.125 $66.375 Last Rec'd Total # Security In At Value Change 12/01/97 6.082 INTC $494.72 $422.68 ($72.04) 11/14/97 1.000 JNJ $62.13 $66.38 $4.25 Base: $900.00 Cash: $389.75** Total: $882.68 The Drip Portfolio has been divided into 41.647 shares |
