Intel-ligent Valuation?
Comparing Intel to Dell

by Brian Graney (TMFPanic)

ALEXANDRIA, VA (June 4, 1999) -- I told Jeff that I was swearing off writing about Intel (Nasdaq: INTC) for awhile after last Friday's column, but today I'm throwing that promise out the window. Sorry, Jeff. Like Teddy Kennedy passing a bar on his way home from work, I can't stay away. The temptation to write about our largest holding is just too great for this mere Fool to resist.

Over on the Intel message board, the issue of Intel's current P/E ratio relative to other PC-related stocks has come up. If you are an Intel Dripper and you're not regularly reading the Intel board here at the Fool, you're missing out on something special. The conversation is almost always lively and thought-provoking, and I find the insights given on a daily basis by the chip industry veterans who frequent the board (including several Intel employees) perpetually illuminating. Best of all, you get the whole she-bang for free.

Public service announcements aside, Intel currently sports a forward P/E of 22. A comparison to direct PC marketer Dell's (Nasdaq: DELL) forward P/E of 45 suggests that maybe something is amiss. Isn't Intel going to benefit from the growth of the PC industry just as much as Dell and the other boxmakers? Is this apparent valuation discrepancy justified? Or is Intel simply being left out of the "tech stock" bloated valuation hoopla -- a trait of today's market that is harped on over and over by the press like some never-ending Gregorian chant?

Whenever we talk about valuation, Jeff and I tend to key-in on cash flows. Stocks are priced based on future cash flows, and for better or for worse (usually worse) earnings are the Street's preferred accounting proxy for cash flows. Compare one to the other, and you've got P/E. That's why being able to project future cash flows is so important to investors trying to put a value on a business and also why we spend so much time around here screaming about cash flows from atop our online investment soapboxes.

What's interesting about the current Intel-Dell P/E situation is that it is just the reverse of two years ago. Back in 1997, Dell struggled to maintain a P/E in the 20s -- Intel's neck of the woods. At the time, Fool Randy Befumo chalked up Dell's low P/E to "hand-wringing about the hyper-competitive nature of the personal computer business and complaints about its commodity nature." Sound familiar, Intel investors?

However, an even more compelling explanation for Dell's relatively low P/E back in 1997 was that the market was consistently underestimating the degree of leverage in Dell's business model, leading to understated future cash flow projections. Two years and 700% in share price appreciation later, the market has finally gotten Dell's story straight. Toss in Dell's virtually unrivaled ability to regularly spit out two dollars for every dollar of capital invested in the business and we are well on our way toward explaining Dell's current P/E, I think.

On the other hand, Intel's current low valuation relative to Dell is reflecting a hodgepodge of fears and worries. Revenue growth lately has been minimal. Falling average selling prices (ASP) in the low-end of the PC market are causing Intel's overall margins to decline. The amount of free cash flow being thrown off by the business is declining quarter by quarter and was down 40% from 1997 to 1998. And the whole move to networking and Internet data centers throws new uncertainties about Intel's future into the mix. These factors make projecting future cash flows (read: earnings) at the company difficult. Thus the declining stock price and the lower P/E relative to Dell, in my opinion.

So, is this a good time for Drippers to make larger monthly optional cash purchases (OCP) of Intel stock? Based on the P/E ratio alone, that may seem like a good idea. But allocating a greater amount of your own hard-earned monthly cash flow based on the relative level of a single data point at some fixed moment in time may not be the best route for bit-by-bit Drippers. If you have followed Intel for a long time and have developed a sense of the company's hard-to-pinpoint intrinsic value, it's better to use that as your guide than the P/E. We'll probably examine this issue further in another Intel column.

Remember, stock prices (and the P/E ratios that are related to them) move according to changes in expectations. Change the current picture with new information of any type, and the expectations for Intel will change in lockstep. As Fools, our job is to figure out if the expectations priced into the current share price are correct or not.

Touchstone Friday: It was a short stock market week, thanks to Monday's Memorial Day holiday. Quite frankly, we wish the market would observe more holidays. Next Monday, for instance, New Zealanders will be celebrating the Queen's Birthday. Why not close the market for that day, too? The market already closes for two days every week and nobody seems to mind. Keeping investors eyes off of the daily gyrations of the market more often sounds good to us, although brokers might not like it.

On Tuesday, Vince discussed selling Drips and suggested a few ways to keep costs to a minimum. On Wednesday, George headed to the land of the rising sun and took a look at Japanese communications company NTT. And on Thursday, Jeff highlighted a few of the great discussions that are taking place on the Drip Companies and Drip Basics message boards here at the Fool. We plan to feature other discussions from the boards in future columns, so keep the great posts coming!

Have a great weekend!

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