P4: A Catastrophic Effect on Margins

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By TMFCheeze
April 18, 2001

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Inteltrader writes:
I have been very clear about why I think using today's trailing PE will mislead investors. I have also made it very clear that I am trying to situate myself as an investor in Dec 2001, and viewing the world from there. An investor in Dec 2001 would look at his Intel stock with trailing growth of -70% or more, EPS of 45 cents to 70 cents, a trailing PE of 40-62, and 5 year forward growth of 18%, and say, "oh cr@p! this stock is overvalued."

Okay, I'm new to this board. I'm not an Intel shareholder, nor an AMD shareholder, nor am I likely to invest in either company any time soon. It's clear that this is an old, old fight, and not my fight, but I've been reading along quietly for some days and maybe I can offer a point of view that can push the discussion in a more useful direction.

Inteltrader's objections rest largely on P/E and PEG ratios. That's fine, as far as it goes. PEG is a handy rule of thumb in certain circumstances, but perhaps it should be pointed out (if it hasn't already) that the PEG is not terribly useful as a valuation tool for large-cap stocks like Intel. It's really far better suited for small-to-medium range growth companies where you don't find cyclical distortions in the growth rates that will disrupt your calculations, much as the current tech recession is causing. PEG works best when you have nice, smooth growth curves to work with -- not the herky-jerky cyclical spurts and stops like those you get in the semiconductor industry.

For example: Intel reported $1.51 in earnings for FY 2000. Estimates show an expectation for 65 cents per share in FY 2001. That's a 57% decline in earnings year over year. Nasty. However, the expectations for FY 2002 are much rosier, with analysts projecting profits amounting to 94 cents per share. That's 45% growth, year over year. If everyone knows that a whipsaw in earnings growth rates is occurring, from 57% down to 45% up, a PEG calculation is just not going to make a whole lot of sense when trying to justify or refute current valuations. Recessions come and go, and cyclical industries revive with the waves of the business cycle. Therefore, investors are not likely, as a group, to be turning to PEG as the main tool for their analysis, nor should they, because under such circumstances PEG will be next to useless. A valuation argument based solely on these devices will necessarily be both superficial and unconvincing.

It would seem to me that an investor in Intel today would find more success in asking himself what a post-recession Intel will look like. Will it be dominating the world like it has in years past? Will its earnings be charging upward -- perhaps not as strongly as it did when it was still in its high growth cycle, but impressive and healthy nonetheless? Will current competitive concerns continue to dog Intel, or will it once again take a commanding lead in its product performance? What will its balance sheet look like? Its profit margins? Its prospects for continued earnings growth?

We are in an anomalous period for Intel, and the current TTM earnings numbers are simply not going to tell the whole story for investors about this company. It strikes me as odd that the conversation here should be so contentious, considering that the matters under debate are so inconsequential. It seems to me that the real meat of the issue has far more to do with the prospects for long-term performance for Intel as an innovator, a marketing force, and a profit generator, than anything that we can judge dimly by focusing on such ephemeral issues as near-term profits and earnings growth rates, especially given that they are so warped by the distortions in the business cycle these days as it is.

If I were looking to invest in Intel, I wouldn't be worried about how things might look next December -- not at all. I'd be asking myself where Intel will be five and ten years from now. To me, the debate about current prices, and whether or not INTC will dip below $20, or rise above $40 in the next six or eight months, is pointless in the extreme. What is really needed on this board is a more convincing, more insightful, more thoughtful analysis of the company, either for it or against it. I haven't seen it yet.