Intel Looking Swell

Instead of focusing on the details, I'll offer some general thoughts on what stood out in my mind from Intel's Q4 and full-year 1999 results. Jeff will pipe in with more of the details on Tuesday. He'll also offer his own opinions on things, basically so he can make fun of my conclusions and correct my misguided mistakes (there probably will be many, ensuring that Jeff will have plenty of work to do over the holiday weekend).

As Intel shareholders, we generally use the year-end results to answer a few basic investor questions: How has the company changed since we first started investing in it? (Which was in 1997, by the way.) Do those changes in any way alter our initial investing premise for this company? Do we have more or less confidence in the company's potential future performance than we did a year ago?

It's helpful to think about these issues on a regular basis for the companies you own. As Drippers, our timeframe is very long and our companies are guaranteed to change quite a bit throughout our holding period. We don't blindly send a check every month to Intel or any of our other companies just because that's what we did last year. Certainly, successful Dripping takes commitment and discipline, and lots of it. But it also takes a good deal of common sense, a willingness to think things through, and the flexibility to occasionally rethink old ideas.

Enough with the flaky, inspirational stuff. Let's get down to some hard and fast numbers. The major thing that catches my eye in Intel's financial report is the overall margin performance for 1999, which at 59.7% was up nicely from 1998's 54%. This year, the company is shooting to hold its gross margin steady at the 61% level reported in Q4. This is what we want to see from Intel -- rising margins over time.

Why are margins so important? Despite the many changes that Intel has made to its business over the past year -- new investments in wireless, networking, and online services, among other areas -- the microprocessor business remains the core of the operation. In 1999, chips and related components in the Intel Architecture Business Group represented 86% of revenues and 100% of operating profits. The revenue figure is down from 91% in 1998, but it is still substantial.

While certainly not the whole story, margins are the main drivers of this business, truth be told. They also offer the best quantitative reflection of Intel's key competitive advantages and strong business economics, namely its manufacturing efficiency, low-cost production, and large-scale output. When margins go up, that leads to higher overall earnings and, in turn, a higher market multiple on those earnings -- AND NOT THE OTHER WAY AROUND.

It is crucial to understand that the price-to-earnings ratio (P/E) and other results-based valuation tools are reflections of a business's value drivers and not the actual value drivers themselves. A Drip investor who is dollar cost averaging money into Intel, as we are, will see better results in the long run by focusing on how the business is performing (the margins and the earnings, among other items) and worrying less about the market's unpredictable short-term reflection of how the business is performing (the P/E).

From that standpoint, Intel is doing quite well. Year-over-year EPS growth in the 22% to 30% area (charges or no charges, take your pick) sounds good to us. If the company can stick to its goal for this year and keep margins steady, then there is no reason to expect that 2000 will not deliver a substantially similar -- if not higher -- earnings growth rate. That's what we are expecting, anyway. Intel seems happy with the outlook as well. "Hey, we're investing heavily, we're trying to grow rapidly, and we think 61% [gross margin] is OK," said CFO Andy Bryant during the conference call. Hey, we agree with you, Andy.

Intel is planning to spend $5 billion on its business in 2000, up from $3.4 billion in 1999. Most of that money will be directed toward the "old standby" microprocessor business, adding capacity to Intel's 0.18-micron chipmaking processes and preparing for the future by investing in next-generation 0.13-micron process technologies. That may sound like a lot of clams, but based on Intel's track record, investing in the business has been a very smart move.

Let's use one of my favorite, newly discovered tools for tracking a company's value-creation ability. Over the past five years, Intel's retained earnings account (earnings that are not paid out to shareholders in the form of dividends or buybacks or used for acquisitions) has jumped from $7 billion to about $22 billion (our estimate). During the same span, the company's market capitalization has ramped up from $56 billion to $287 billion as of the end of 1999. So, every dollar invested in the business over the past five years has turned into more than $15 of market value. And that's excluding the $72 billion market cap expansion so far this year.

We'll take those kinds of results any day of the week, thank you very much. Personally, I like where Intel's business is going and feel confident in the returns the company will reap in the years ahead as a building-block supplier to the Internet. We'll see how Jeff feels about things next week.

Fool on!