Post of the Day
February 23, 1998
From our AOL
Subject: Of Intel And Investing
As INTC has emerged from a six month bear market and is breaking out convincingly over 90, the time is right to reiterate some key rules which should serve all INTC investors well.
1. THERE IS ALWAYS SOMETHING TO WORRY ABOUT.
Macroeconomic factors, the cyclicality of the semiconductor business, potential competitors, the Department of Justice, yields, errata, PC industry growth, market acceptance of accelerated product life cycles, paradigm changes, market acceptance of increased specifications, sub $1000 PC, declining ASP's, timing of market acceptance of killer applications such as 3D, virtual reality, speech recognition, artificial intelligence, analysts ill conceived opinions, Robert Collins and other INTC gadfly's, etc. When analyzing the risk reward ratio, endeavor to determine to what extent these potential threats are valid, and if they are to what extent and what will be the impact on earnings? More often than not, these potential threats turn out to be invalid due to the self-perpetuating monopoly facilitated by INTC's superior business model and execution of it. (e.g. Moore's Law) If you let yourself suffer from paralysis by analysis, you will never be invested in the stock.
To guard against mental myopia, try to focus on the big picture of earnings growth, industry growth, PC growth, competitive activity in terms of capacity and strategic alliances/leverage vis-�-vis top OEM's, and viability of future killer applications.
Also analyze how INTC is re-engineering itself to adapt to changing market dynamics, and the implications these changes have upon the viability of their business model. By segmenting the market and re-structuring to exploit new opportunities, INTC arguably will not endure the same fate of companies such as IBM, AAPL, WANG, and DEC.
2. IF YOU CAN'T EXPLAIN TO A TEN YEAR OLD IN 30 SECONDS WHY YOU OWN THE STOCK, YOU SHOULD NOT OWN IT.
This tenet is borrowed from Peter Lynch, and explains why Lynch and Buffet don't own the stock. The high tech business and semiconductors in particular are very arcane businesses in some respects. However, if you use some basic business acumen and gain understanding of INTC's business model, it helps isolate the key business drivers from the more complex aspects of the business. How would I explain INTC to a ten year old? Try this one on for size. "INTC is the leader by far in making chips that run computers. Computers help people work better, communicate better, make money, and have fun. This makes many people want to own a computer, and no one can make enough chips to run these computers except INTC." As you see, the more you simplify something that is inherently complex, the more compelling is the rationale to own the stock.
3. SEPARATE THE EMOTION FROM THE INTELLECT
INTC and high tech stocks in general are very volatile due to the prolific growth potential and the tremendous risk arising out of the rapidly evolving paradigm changes inherent in the industry. This causes Wall St. to have a love/hate relationship with high tech and especially the cyclical semiconductor stocks. Thus, it behooves an investor to gain a keen understanding of every facet of the business so that you can separate short term herd mentality from long term reality. Wall St. does not care how big the industry will be by 2007, or that INTC will have a billion transistors on a chip by 2011. Nobody makes any money on retail clients with that philosophy. Wall St. must find cogent short term reasons to churn you in and out of stocks several times per year. Knowledge is power, as they say, and the more you have the better you will be able to resist short term volatility. Remember, the same emotion that you acquiesced to in selling the stock will preclude you from buying it back until after you have missed a big rally. This is human nature. For most people, a long term approach is the only viable way to eliminate emotion.
4. Diversification is a hedge against ignorance.
This is another Warren Buffet axiom which has been crucial in my success. If you structure your portfolio in terms of the conventional wisdom, you are destined to achieve the same results as the conventional wisdom. (How many money managers consistently beat the S & P?) Why? Because they are diversified. Consider the football tickets that some people bet on every Sunday. You get 4 to 1 odds for picking three games right, and 10 to 1 odds for picking 4 games right. Why? It is much harder to be pick four games right. It is the same with stocks. The more stocks you invest in, the more difficult it is to become an expert in terms of not only that company's business, but their industry and competitors. You also have to believe in your ability to make decisions based on your research. Very few people have enough conviction in their ability to do this, and find themselves constantly vacillating due to the short term mentality of Wall St. While I do not advocate putting all your money in one stock, INTC is an excellent stock to overweight in your portfolio due to it's dominance of the microprocessor market.
5. IF THE MARKET CLOSED FOR TEN YEARS, WOULD YOU STILL WANT TO OWN THE STOCK.
Another tenet borrowed from Warren Buffet, which is not as applicable to INTC due to the rapid changes inherent in the industry. However, if you keep a long term perspective but monitor the fundamentals as if you were a day trader, you will be in a position to recognize a paradigm shift before the "jack of all trades master of none" money managers. Keeping this perspective will also help you separate the emotion from the intellect, which you need to do given the cyclicality of the semiconductor business. About 9 months ago when it became apparent that the sub $1000 PC would require a revision of INTC strategy, the wisdom of holding INTC for ten years was called into question by many. This is the time in the life of a company where the quality of management is crucial. Superior management meets these so called "strategic inflection points" with vision and decisiveness.
One criterion I always use to evaluate a company's management is to ask the question, "do they worry about doing things right, or do they worry about doing the right things?" Both of these are important, but at different junctures, one will always supersede the other. The wise investor is able to discern which should take priority at any given time relative to the threats and opportunities that exist. If a company's management takes appropriate action to address these threats and opportunities, it dramatically increases the probability that management will continue to take actions that will propagate the business. Thus, you want to own those companies whose management demonstrates this expertise consistently; INTC is such a company.
6. DON'T PULL THE FLOWERS AND WATER THE WEEDS
Relative to the aforementioned point, INTC has proven time and again that they are a company whose superior leadership and vision makes them a compelling long term investment. Many investors over the past year, given the uncertainty and the many challenges facing INTC (to say nothing of the earnings deterioration) took profits on INTC and plowed them into other high tech investments. Many remember all too well when First Call estimates had AMD earning $3.00 per share in 1998, and analysts were projecting a $90 per share stock price for AMD. Once again, another case in point that investors buying hope and hype instead of strong fundamentals are destined to lose. At the risk of beating a dead horse, (for those who have followed my analyses over the past 3 years) economics and marketing are the keys to INTC's success, and those are factors which are not likely to change any time soon. The old adage that you can't break a leg falling out of a basement window is one which will always impede the success of many investors; don't let yourself fall prey to such inane drivel.
7. YOU REAP WHAT YOU SOW
It has been said that turning $100 into $110 is work, but turning $1 million into $1.1 million is inevitable. The bottom line is, there is no substitute for hard work. It is never easy to become wealthy, but it is easy to work harder than most and acquire more knowledge than the typical Wall St. analyst. The truth is, very few people are willing to make this commitment of time and effort. Understanding the business that INTC competes in requires a time commitment on a daily basis.
8. YOU ARE BUYING A BUSINESS, NOT A STOCK
As this relates to INTC, many people who have huge profits in the stock want to sell. However, simply because your INTC investment has increased tenfold is no reason to sell. If you owned your own business and your investment had increased tenfold but you expected your business to triple in the next five years, would you sell? Of course not. It is the same with INTC; never sell unless the fundamentals of the business under which you initially bought the stock have changed. And don't let 4 or 5 quarters of earnings weakness make you pull the trigger too quickly, it is a relatively short time in the life of a corporation. As mentioned before, scrutinize whether management is taking the right steps to regain earnings momentum.
9. PAYING CAPITAL GAINS TAXES EVERY YEAR DELAYS YOUR SUCCESS
Use a little quantitative analysis and determine for yourself the power of compounding. There have been many studies done on this. Also determine for yourself how much more your investments must increase every year to offset the capital gains taxes. Obviously, one should never make investment decisions based on tax considerations. However, there is no reason why you cannot use the increasing equity in your account due to INTC's growth to trade with. (this is not a recommendation, as many do not have the risk tolerance to trade on margin.)
10.ALWAYS BUY THE LEADER
The axiom "I would rather pay a decent price for an exceptional company than a great price for a good company" holds true. In the case of INTC, they got where they are for a reason. Business model, economies of scale, marketing savvy, strategic alliances, visionary leadership, financial muscle, installed base, etc.
Despite the recent hype about NC's, thin clients, Internet appliances, sub $1000 PC's, etc, the paradigm is not changing anytime soon at the high end, and there is no one that can challenge INTC in the high end right now. INTC's next major spurt of earnings growth will come from workstations and servers. And with the advent of Covington and Mendocino, INTC will soon dominate the low end as well. As a corollary to always buying the leader, consider this. When there is a war going on, always buy those companies that make the bullets, not those that are fighting the war. INTC is such a company, as are my other two favorite stocks. The PC business is evolving as a commodity business, especially as INTC begins to incorporate more functions into their chips. (look out COMS) In a commodity business, there is no product differentiation, thus competition is based solely on price. INTC's business is highly capital intensive, which is another key reason why they will remain the leader. Another corollary to Moore's law: The cost of a fab doubles every three years. Right now the cost of a new fab is $2 billion, which means the cost will be $4 billion in 2000, and $8 billion in 2004. No other company will be able or willing to invest that kind of capital to build fabs for demand that will not exist for at least two years. There will be further consolidation by competition to address this, in the form of consortiums, increased use of foundries, strategic alliances, and joint ventures. Notwithstanding, the odds are still heavily in INTC's favor.
There are only three sure things in the market. Earnings growth and stock prices moving in lockstep over the long run, volatility, and the passage of time. Pertinent to this, how am I capitalizing on all three? I continue holding my long term position that I have held since 1993. I use margin to trade Leaps, using spreads to hedge and make money whether the stock moves up or down. I write covered calls using the Jan 99 120. However, I would not advise doing this right now, as all the Wall St. lemmings who hated the stock at 70 are jumping back in.
Disclaimer: This is not a recommendation to buy or sell options, or INTC stock.