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Buy Intel: A Stock For All Seasons

In an increasingly challenging market, Intel [INTC] is one of the safest investments with compelling upside potential. That’s right, investors get to have their cake and eat it too – at least for now.

As one of January’s Most Attractive stocks, INTC offers the rare com­bi­na­tion of strong cash flow growth with a remark­ably cheap val­u­a­tion. Investors were rewarded hand­somely over the last 9 months after I recommended buying the stock at under $21 (see “Back Up the Truck”).

First, on the safety of investing in INTC: with return on its invested capital (ROIC) at 32%, Intel has one of the strongest business models in the business. The company generates very strong economic earnings. So much, in fact, that the company can afford to pay a generous dividend (3.3% yield) while also building cash reserves ($20 billion) and making strategic investments such as Infi­neon Tech­nolo­gies (IFNNY), maker of the chips inside the iPhone 3GS.

This strong per­for­mance under­scores the strength of INTC’s busi­ness and the abil­ity of its man­age­ment team to allo­cate cap­i­tal intel­li­gently. They have made mis­takes along the way, even somewhat recently with the recall of its “Core i7” chip. How­ever, mis­takes for INTC are the excep­tion not the rule. Over the last thir­teen years, INTC has gen­er­ated pos­i­tive eco­nomic earn­ings every year except for two, an accom­plish­ment matched by only a hand­ful of com­pa­nies in the world.

INTC is and will continue to be one of the strongest and best-positioned companies in the high-growth-potential semi-conductor sector.

Second on the upside potential, the value of the stock assuming no future profit growth is $28.50. In other words, the current stock price, $25.14 as of close on 1/13, implies the company’s profits will permanently decline by 10%. Those are some very low expectations, which means downside potential in the stock is limited compared to upside potential.

Bears will argue that supply disruptions will hurt Intel’s earnings. To which I reply, it is true that short-term earnings may suffer because of flooding in Thailand. However, as long as the supply disruption is temporary as it appears to be, the long-term cash flows of the stock are not diminished. As long as there is demand for INTC’s products, the cash flows will be there.

The continued proliferation of electronic devices is a strong indication that demand for semi-conductors and processors remains strong. Though a severe global economic slowdown could dent the valuations of nearly all assets, I would still expect INTC to be a top performer given the steady nature of its cash flows and the fact that demand for electronics is likely to hold up. Electronics and processors are increasingly embedded in more and more things, even our toasters can talk to us now.

The technician will point to INTC trading near the top of a long-term trading range and bouncing off a long-term resistance level. To which I reply, this is not a momentum story. My thesis is based on the firmer ground of fundamental analysis of cash flows and valuation. I prefer not to rely on the past to predict the future.

If you intend to be an investor, as dis­tinct from a spec­u­la­tor, then there is only one, true way to out-perform over time and that is with supe­rior fun­da­men­tal research.

For investors wary of investing in any single stock, I recommend the following ETFs because they have the largest allocations to INTC and get my “attractive” fund rating:

  1. ProShares Ultra Semiconductors [USD] allocates 37% to INTC
  2. Market Vectors Semiconductor ETF [SMH] allocates 20% to INTC

Note there are no mutual funds that get an “attractive”-or-better rating and make large allocations to INTC. The mutual fund that makes the largest allocation (12%) to INTC is the Rydex Series Funds: Electronics Fund [RYSIX] gets my “dangerous” rating based on holdings as of 11/30/11. The next largest allocation by a mutual fund is 9% for the Invesco Van Kampen Exchange Fund [ACEHX], which gets my “neutral” rating based on holdings as of 10/31/11.

These funds do not earn “attractive” or better ratings despite their large allocations to INTC because they allocate too much of the rest of their portfolios to “neutral”-or-worse rated stocks. RYSIX also happens to have very high costs at 5.5% annualized over three years, which warrants our “very dangerous” rating for Total Annual Costs. More details are in my RYSIX report here. My ACEHX report is here.

New Constructs’ free fund screener provides my predictive ratings on 6000+ mutual funds and 400+ ETFs.

Disclosure: I am long INTC. I receive no compensation to write about any specific stock, sector or theme.

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