As investors, we always want our investments to generate healthy returns. However, investors often forget that such returns stem from two extremely important factors:

  1. The business's ability to generate profits.
  2. The price you pay for one share of those profits.

This idea of price vs. returns lies at the heart of value investing. In today's edition of this series, I'll examine both the quality and the pricing of chipmaker Intel (Nasdaq: INTC), in hopes of gaining a better sense of its potential as an investment right now.

Where should we start to find value?
As we all know, businesses' quality varies widely. A company that can grow its bottom line faster than the market, especially if it does so with any consistency, obviously gives its owner greater value than a stagnant or declining business. However, many investors also fail to understand that any business can become a buy at a low enough price. Figuring out this price-to-value equation drives all intelligent investment research.

For today's spotlighted stock, I selected several metrics to evaluate returns, profitability, growth, and leverage:

  • Return on equity divides net income by shareholder's equity, highlighting the return that a company generates for its equity base.
  • The EBIT (short for earnings before interest and taxes) margin provides a rough measurement of the percent of cash a company keeps from its operations. I prefer using EBIT to other measurements because it focuses more exclusively on the performance of a company's core business. Stripping out interest and taxes makes these figures less susceptible to dubious accounting distortions.
  • The EBIT growth rate demonstrates whether a company can expand its business.
  • Finally, the debt-to-equity ratio reveals how much leverage a company employs to fund its operations. Some companies have a track record of wisely managing high debt levels, but generally speaking, lower is better here. I chose five-year averages to help smooth away one-year irregularities that can easily distort regular business results.  

With that in mind, let's look at Intel and some of its closest peers:

Company Name

Return on Equity (5-year avg.)

EBIT Margin (5-year avg.)

EBIT Growth (5-year avg.)

Total Debt / Equity

Intel 16.03% 25.27% 14.39% 4.51%
Advanced Micro Devices (NYSE: AMD) (26.98%) (5.91%) 85.78% 143.13%
NVIDIA (Nasdaq: NVDA) 12.97% 8.22% 175.24% 0.74%
SanDisk (Nasdaq: SNDK) 0.07% 8.68% 46.78% 28.96%

Source: Capital IQ, a Standard & Poor's company.

Intel looks like the clear leader of this pack from a performance standpoint, with impressive metrics in all four categories on both a relative and absolute basis. I'm struck by how consistently Intel performed from year to year, another plus in my book.

AMD looks far less consistent. Like other highly leveraged companies, it puts up great performance in the good times, but tanks when times get tough. (Just look at that -136% ROE in 2008!)

I'm far more impressed by NVIDIA. While it lacks some of Intel's consistency, it puts up fair-to-strong performance and margins. However, it also has the best growth story among the four, an extremely important metric for most tech investors (though not me).

San Disk's five-year average figure somewhat masks its true performance. Though it got hit hard by the Great Recession, with a -47.3% ROE and -27.4% EBIT margin in 2008, its other years of performance seem acceptable. In addition, most of SanDisk's impressive growth figures seem to have come early on in the five-year period, another potential cause for concern.

How cheap does Intel look?
To gauge pricing, I studied two important multiples: price to earnings and enterprise value to free cash flow. Similar to a P/E ratio, comparing enterprise value (essentially, debt, preferred stock, and equity holders combined, minus cash) to unlevered free cash flow conveys how expensive the entire company is versus the cash it can generate. This gives investors another measurement of cheapness when analyzing a stock. For both metrics, the lower the multiple, the better.

Let's check these companies' performance against the price we'd need to pay to get our hands on their shares:

Company

Enterprise Value / FCF

P / LTM diluted EPS before Extra Items

Intel 9.83 10.66
Advanced Micro Devices NM* 9.20
NVIDIA 15.82 45.37
SanDisk 7.84 9.21

Source: Capital IQ, a Standard & Poor's company.
*Because of losses.

Intel looks enticing, trading at low multiples despite its outstanding core business. AMD's negative EV/FCF ratio gives me pause, since negative cash from operations drove this figure. If the company had instead run negative because it made capital expenditures, I might have cut it some slack. Like many strong growth stories, NVIDIA looks expensive, especially on the P/E front. SanDisk, by comparison, looks pretty compelling at its low price multiples.

In reviewing these numbers, Intel looks like the most favorable risk/reward proposition. In my mind, this stock certainly could deserve a spot in your portfolio. Personally, I'd pass on AMD and NVIDIA, although I typically avoid big growth stories anyway. If you gravitate more toward the such investments, you might want to give these two some more in-depth analysis. Finally, I like SanDisk, although not as much as Intel. It seems to have a relatively strong core business selling at a cheap price.

While Intel looks like a great stock for your portfolio right now, your search shouldn't end here. In order to really get to know a company, you need to keep digging. If any of the companies mentioned here today pique your interest, you can continue your research by examining their quality of earnings, management track record, and analyst estimates, among other metrics.

Need a little help? Stop by Motley Fool CAPS, where our users share ideas and chat about their favorite stocks, or click here to add the four stocks I've covered here to My Watchlist. Our new, free watchlist service will keep you up to date with Foolish coverage of any developments surrounding Intel and its competitors.

Intel is a Motley Fool Inside Value recommendation. NVIDIA is a Motley Fool Stock Advisor pick. Intel is a Motley Fool Income Investor selection. The Fool owns shares of and has bought calls on Intel. Motley Fool Options has recommended a diagonal call position on Intel. Motley Fool Options has recommended writing puts on NVIDIA.

Try any of our Foolish newsletter services free for 30 days. Andrew Tonner holds no position in any of the companies mentioned in this article. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.