Friday, December 28, 2012

Is Intel Corporation the Ultimate Value Trap for Investors?

Intel Corporation (INTC) designs, manufactures, and sells integrated digital technology platforms primarily in the Asia-Pacific, the Americas, Europe, and Japan. This dividend achiever has paid dividends since 1992 an increased them for 10 years in a row.

The company’s last dividend increase was in July 2012 when the Board of Directors approved a 7.10% increase to 22.50 cents/share. The company’s peer group includes Altera (ALTR), Xilinx (XLNX) and Advanced Micro Devices (AMD).

Over the past decade this dividend growth stock has delivered an annualized total return of 4.50% to its shareholders.

The company has managed to deliver a 20.10% average increase in annual EPS since 2002. Most of the increase came over the past two years however. Before that, earnings were following a rollercoaster pattern. Analysts expect Intel to earn $2.10 per share in 2012 and $2.03 per share in 2013. In comparison, the company earned $2.37/share in 2011.

The company is the dominant supplier of microchips for the computer industry worldwide. Its heavy investment in R&D have ensured that it maintains its dominant position in the market. Unfortunately, the market for traditional computers and notebooks is starting a long decline in units sold as more consumers are going mobile and embracing tablets. Intel has not been very successful in gathering a key position as a supplier of semiconductors for tablets and mobile phones. While shares are really cheap and trading at a super low P/E ratio, the real question is whether earnings will be flat over time or whether they will decrease. If earnings dip due to declines in PC sales and company’s inability to break into mobile, further growth in the dividend will be severely limited and it might even be at risk for a cut. Technology companies are notorious for being in an industry where rapid changes in products due to innovation lead to obsolescence and loss of consumers and revenues. As a dividend investor, I keep asking myself whether the dividend is secure, and whether I can rely on it for the next decade and beyond. While the yield is very high, I have strong doubts that the party would last for long. Even under the best case scenario, it looks like flat earnings would limit growth in distributions, but investors would still get paid a very respectable 4.50% yield for a few years. Shares might even double in value, mostly due to P/E multiple expansion. Of course, what happens if the market actually expects an EPS of $1/share by 2020?

That being said, given the fact that Intel is a market leader in the still very lucrative semiconductor market for PC’s, it has the scale to deliver product at a lower cost than competitors such as AMD. I doubt that the PC is going away, as I simply cannot foresee all businesses replacing computers with tablets. However, companies that end up selling less product than anticipated, might end up with extra inventory that might have to be written down. Inventory obsolescence is a particular concern for technology companies, because technology changes so quickly.

The return on equity has closely followed the trends in earnings per share over the past decade. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time.

The annual dividend payment has increased by 25.60% per year over the past decade, which is higher than the growth in EPS.

A 25% growth in distributions translates into the dividend payment doubling every three years on average. If we look at historical data, going as far back as 1994, one would notice that the company had managed to double distributions every three years on average.

The dividend payout ratio has increased from 17.40% in 2002 to 72.70% in 2009, before reaching a more sustainable 32.60 % in 2011. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Currently Intel is trading at 8.80 times earnings, yields 4.50% and has a sustainable distribution. Despite the ultra-low valuation, I am hesitant to pull the trigger on this one, due to my inability to determine whether Intel will be able to keep innovating and maintain profitability in the long run.  Because of my inability to gauge whether tectonic shifts in technologies will impact the long-term picture for Intel, I will maintain a hold opinion on the stock. I am also unable to determine whether Intel will be able to boost earnings in the near term. That being said, the company’s shares can easily rebound from current lows, and its dividend yield would probably be sustained for the next several years. In addition, it also would add some exposure to technology for my income portfolio. While I am neutral on the stock, I plan on initiating a small started position by the beginning of next year, subject to availability of funds.

Full Disclosure: None

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  1. Excellent post on the "state of the union" so to speak for Intel. I agree that there is a certain degree of uncertainty around the future of the company, particularly with the shift away from a PC-based world. I do believe that Intel will be able to innovate however, and with their marketing muscle and brand recognition they will succeed.

  2. I have been avoiding this stock all year although the yield and pe look tempting. Actually, I avoid most tech stocks anyway, since how can we know what new gizmo will come out next and turn everything on its head? I dont think technology and conservative dividend investing are good teammates

  3. DGi,
    I have read many online comments where DG investors have initiated a postion in Intel. I feel much the same as High Yield Soldier and will be staying away. I too lack tech in my portfolio and try to make up for it a bit with diversified companies that are involved with technology such as MMM or DOV. I appreciate your concerns with Intel and share them. I've not read such apprehension from you in a reviewed stock as far as I can recall. Let me suggest that sometimes when one is not sure quite what to do, if possible, do nothing at all. This may not be a 'forever' stock. If I were to initiate a position myself, it would be small.

    Happy New Year!


  4. I am long on INTC, too long actually. INTC will stay strong over the long, but there will be price volatility. When buying shares, good to examine the technicals and NASDAQ index.

  5. Thanks everyone for your comments. To clarify, if I consider initiating a position in INTC, it would be small and for speculative purposes (capture 40% potential upswing). I do not see INTC as a major DG stock for inclusion for a LT DG portfolio.

  6. Great post.

    Totally agree, I don't own INTC or any tech for that matter. Too fickle industry.

    Contrary to what many believe, you don't need a new computer or tablet every year.

    Do you need to heat your home, put gas in your car, and food on your table. The companies that provide those goods and services are what I invest in.

    Happy New Year!

  7. I'm totally bearish on Intel (and Microsoft for that matter). Companies are actively looking at PC replacement strategies in enterprise (upgrades are difficult, many workers dont require one and who wants to pay microsoft an enterprise wide license for windows!). The PC space is flatlining and the mobile processor market is owned by qualcom and nvidia at the moment.

  8. Interesting. Was thinking about drafting a similar post on my blog, but not sure I have much to add.
    On a somewhat related note, I added Microsoft a few months go, but it suffers from many of the same issues as Intel, and can't say I am married to the pick. I have no doubt they can both remain dividend increasers, but my citeria requires capital appreciation as well. Will stay with Microsoft for awhile yet, but if I become convinced it is going to revert to languishing in a trading range (like it had been for much of the last decade) I will likely exit.

  9. I view INTC in the "high potential reward" category. Especially when you consider the current price point and historical dividend growth. I too worry about the ability of a technology company to gain/maintain market share and relevance in the future. Over the last 12 months, I have also been closely watching CSCO. It doesn't have the long-term dividend history but the potential is there for exponential dividend growth.

  10. Excellent post DGI! and I happen to completely agree with you. This will end up being a long-term value trap for many investors. In fact, I;m convinced we will see declining margins as early as this year for Intel. ;)

    In the short-term I think Intel is a great investment,in the long run, not so much. I argued this point in a previous post at DSO:

    Intel's profit and growth has largely been on the back of PC sales which have soared over thelast few years, but that's changing. While we will always have PCs and Servers, which intel chips run, Intel hasn't been able to adapt to the new market.

    You simply can't invest in Intel, and pretend that the advance of the mobile market has not impacted their bottom line. Their R&D costs are enourmous. I believe investing in Intel is much like investing in Apple. I think its too late to start initiating a position.

    The Dividend Ninja

  11. I agree that INTC is a value trap. I would also stay away from dell, which is also a value trap in my opinion

  12. INTC isn't like MSFT at all. INTC products aren't competing against free products.

    I love INTC long term and have made my first purchases ever at $21-22. This isn't a hyper growth stock anymore. It's a mature company with a massive financial and research moat compared to their competitors.
    6x cash flow. 10x earnings. 4+% dividend yield. If they produced bleach you'd love that. Instead they produce a product very few companies in the world can compete with. Markets have changed, it's hit their earnings as they regroup. At $9 billion per year in research and development - that's an investment that will continue to pay off long term IMO.


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