Yup, Intel Remains a Great Buy

In my new article I talk about why I think that Intel remains a great buy, despite its recent share-price appreciation.  As always huge risks exist, but I think the company is at the current price of around $28/share, because it is 20% or greater below my best guess as to the fair value of the company, of $35/share.  I also highlight the three best analyst questions from the recent conference call, and I express my worries about recent stock options/sales by the CEO.  For my full article, see here.

Apple: Updated Analysis

I just published a new analysis on SeekingAlpha of Apple, looking at it from a discounted cash flow perspective, incorporating the new cash-on-hand numbers.  To me, it seems highly undervalued.  The full article is here.

Please follow me on Twitter at @The_Dumb_Money.

Microsoft: A Brief Checkup on My Largest Position Says It’s A-OK

For some time, Microsoft has been the largest position in my portfolio.  I first added around $19/share during the financial crisis.  That was based on more of a knee-jerk “holy crap that’s cheap and no the world is not ending” analysis.  Subsequently I did a lot more real analysis, after which I added around $24/share, and I added in late 2010 at around $28/share, in March 2011 at around $25.50/share and last Fall around $27/share.  Today the stock is still either: 1) stupid-stupid-stupid-stupid cheap (as in, undervalued by 30% or more); or 2) Windows 8 and everything else is actually going to fail and it is going to go into terminal decline.  You pick.

But first, how did we get here.  Well my original thesis went like this, written on February 20, 2010, though developed before then:

In yet another sign of the insanity of the late 90s, and the myopia of today, MSFT is selling now at about what it sold for twelve years ago! Except now it is vastly more profitable, pays a decent and growing dividend, and has diversified its business somewhat from the Windows/Office core. The dividend is nearly 2%, and growing, and the payout ratio is quite low, leaving significant room for growth. I bought in for the first time at around $19/share during the market bottom, and may add to my position on further weakness. P/E is sub-16. MSFT is the “uncool” tech company now. AAPL is a better company, but shareholders face HUGE risks b/c so much innovation comes from Jobs, who just had a liver transplant and may not be around much longer — look what happened to AAPL the last time he went away.

(Note that I subsequently resolved my worries about Apple, and bought in 2011, late, at $365/share for my first purchases, then again at $390ish in 2011 and again on 4/23/2012 at $570ish, and Apple is now my fourth largest position.  I got rid of the false dichotomy, too, of thinking everything had to be either Apple or Microsoft, or Google or Microsoft, etc.) 

Then on September 28, 2010 I wrote this:

I believe MSFT is, as of today, the most undervalued stock in my portfolio. DCF, assuming an 11.1% [which is too high] weighted average cost of capital, and 3% terminal growth, yields an intrinsic share value of $34. That may be a bit high, but MSFT is worth at least $28 or $28/share, as of today today.

On February 7, 2011 I wrote:

The market appears totally convinced that MSFT is on the verge of losing its Windows and/or Office moat, and/or that growth in that area will be so low that the company will not grow, and/or that MSFT’s failure thus far to get involved meaningfully in the mobile market means it cannot succeed in doing so. I have never seen so much negativity surrounding one company that had not been involved in a major oil spill (XOM shortly before I bought it), major litigation (MO, shortly before I bought it). With MSFT I am just going to have to continue to trust the numbers. Revenues are growing, free cash flow is exploding, margins remain solid, triple-A rating, issues debt at stupendously low rates….I’m going to put this another way: If you assume a discount rate of 12%, which is more conservative than either Morningstar or S&P use when evaluating MSFT, and you assume MSFT will grow free cash flow 5% for ten years (which is less than the previous 10-year average of 6.9% annually, and less than half what MSFT has managed (11+%) since 2007), with 2% perpetuity growth, then counting MSFT’s cash on hand, netting out its debt, the company is worth $34.68/share today, implying a 20% discount. Even if you change the discount rate to 14% it would be undervalued. If at a discount rate of 12% one assumes it can grow FCF simply at 6.9%, which is its average over the last ten years, and is also its recent rate of revenue growth, then the stock is worth $38.35/share, for a 29% discount. This is not rocket science. At a 12% discount rate, even assuming only 2% FCF growth from now until eternity, you would be getting more than a 5% discount by buying MSFT today. Am I smoking something? Seriously, am I just spank out of my mind? What is going on with this stock?

So where are we now?

Well, unless I have totally screwed up my free cash flow spreadsheet, which you can link to and view here (if you ask I’ll give you editing rights so you can look at my formulas and mess with things), Microsoft is still basically priced for Armageddon.  I’m still thinking and saying the same things I was saying a year ago and two years ago.  If you assume a calculated WACC of 9.2% for Microsoft, then to be fairly priced today you have to believe that Microsoft’s free cash flow will basically contract from here on out.  Seriously, play with the sheet.  The numbers are right there.  (That’s assuming free cash flow growth starting from June 2011’s annualized figure, even though June 2012’s, to which we are closer, will be significantly higher.)

If you assume Microsoft can grow its free cash flow by just 4% per year for ten years (which is one third of what it has grown it on annualized rate through the past four years — during the “iPhone Era” I might add), then Microsoft is around 28% undervalued.  (The sheet is presently set up to reflect this assumption.)  Under those assumptions, it is a buy up to about $36.20/share. 

Not only that, dear reader, but to get there there are more conservative assumptions.  In my sheet I discount the $59.3 billion in cash and equivalents on hand by 35% to account for repatriation tax, even though not all of it is held abroad, and no tax may ever be paid even on what is held abroad.  AND I only give MSFT a post-ten-year 1% perpetuity growth rate, which is a population growth rate that is below inflation.  In short, this is a conservative calculation.

What’s going on here?  I suspect people would say (note, I suspect this because they DO say it), that: a) Microsoft is going to go the way of Research in Motion and that b) relatedly, the WACC is too low, whatever the math seems to say, because it’s just not as stable as it seems, and c) Microsoft wastes its free cash flow so you can’t count all of it.

This is where you have to put on your English major and tech analyst hat.  This story doesn’t make sense, or it only makes sense in part.  Yes, there is cash flow wastage.  Bing, et al.  And attempted wastage: failed Yahoo acquisition.  Yes the PC market is mature, and being eroded by the iPad.  But there is a lot of organic growth left to be had around the world.  Microsoft has grown healthily even during the iPhone era so far.  Many businesses have not even upgraded to Windows 7 because they are happy running Windows XP (service for which will shortly be phased out) and have delayed upgrades.  So even if businesses don’t want Windows 8, they’ll be upgrading to Windows 7 for years to come.  And at least at this point Microsoft still has a chance in tablets and phones.  It has expanded its gaming business.  Office is going strong, cloud notwithstanding.  Servers and tools is now something like more than 1/4 (without rechecking) of the company, and growing.

So you have a choice with Microsoft: do you think it’s going to fail?  Or do you think it’s going to be fine, and is stupid cheap?  I very well could be wrong, but I think the latter, and have thought it for two years.  Believe me, I watch the numbers carefully to see if I’m wrong.  I believe that there will be pretty clear signs that Microsoft is truly losing its Windows and Office franchises, if it happens.  But so far, in the two years I have been closely following it (including this past quarter), I have seen nothing to indicate Microsoft is going down.  And I still do not.

On a broader note, I am sick of fads masquerading as themes.  I have been around the block a couple of times by now.  In 1998 tech companies were God.  They were unassailable.  Drug companies were god.  They too were unassailable.  In 1998 Altria/Philip Morris was a turd pile (it crushed the S&P index from then until now, just crushed, including spinoffs).  In 2004-2007 houses were God.  In the 1990s the big thing was for oil companies to merge, and to “vertically integrate.”  Now COP’s split into two companies is hailed as visionary and people want Exxon to do so as well.  Waves and tides, nothing more.  Now, too, the Sophisticated Investing and Blogging Elites think tech is “inherently unstable” and a “no moat industry” and that every company no matter how big is inches away from some tiny competitor blowing them up.  The pace of change is now scary, not exciting.  Anyway, all of this is why most of the tech and drug companies were a crap place to invest in in 1998 (when I was buying Philip Morris), why houses were terrible in 2007 (when I was putting my life savings in a 5% one year FDIC-insured CD) and why, astoundingly, Google, Microsoft, and Apple are all simultaneously some of the most undervalued stocks in the market today.  We need to get rid of the fad and themes, people, and just look at the numbers.

“Trader Arbitrage” and an Actual Apple Valuation Analysis

I have been holding Apple stock since mid-ish 2011.  I bought “late”, in the $350 to $365 range.  I bought because my analysis showed a twenty percent discount to this model’s (the linked chart has since been updated — see below) estimate of the value of the firm.  I have not added shares since then.  I have watched the recent rise with amusement, happiness, and some trepidation.  I have also avidly followed how the technical guys, the traders, think about it.*  (I generally find them amusing, and I am grateful as a citizen for all of the capital gains taxes they pay each year in exchange for their unceasing and frenetic efforts.)

The setup.  I think the parabolic move upwards to $640 was driven both by fundamentals and by technicals.  To some extent, all multiple expansions are a technical phenomena, no matter the fundamental component.  And it’s clear to me right now that Apple as it swoons is in the hands of these technical traders, these chartists, the algorithms.  No substantive news is driving this, I think.  These guys (they’re typically guys it seems) have followed and exacerbated that move up.  And now that it blew back through $600 on the downside there is blood in the water.  

And it’s not just solo guys, however professional.  The stock has been a favorite of hedge funds, too: everyone has/had to own it.  Billions of dollars, controlled by charting/technical algorithms written by former electrical engineering and physics majors and professors, trade according to such charting schemes.  They don’t care that Apple has a 10ish forward P/E. They don’t care that it has a super low PEG.  They don’t care about recent revenue growth.  They don’t care about free cash flow (more on that below).  They.  Don’t.  Care.  Here’s what they care about: price targets based on what the charts say.  Now $553 is a major target for these folks.  The most aggressive of them quote the history of retracements of parabolic moves and say it will go back to $430.  

Thus I hereby inaugurate the concept of “Trader Arbitrage.”  This is seeing whether technical charting guys manage to drive the stock vastly down below intrinsic value, and if they do, to thank them and arbitrage their short-term mindset to harvest a sweet buying opportunity.

Let’s review the value of the firm.  As the cash flow sheet states, this is a bit of a “rough-and-dirty.”  Recent yearly free cash flow was over $30 billion.  There is also $100 billion in cash on hand, which I discount by 35%, which is aggressive.  (Recent plans announced for dividend and stock buy-backs, both good ideas.)  For my discount rate I am using Apple’s WACC, which is 10ish% (WACC calculation can vary, note).  The chart I am linking to currently shows the value, assuming my 12% growth estimate for ten years.

Anyway, ladies and gentlemen, the numbers say that if Apple can even grow its free cash flow at 6% for the next ten years, and then 2% in perpetuity, it is worth it’s share price as of this writing, $580ish.  

That’s pretty conservative.  I am not a “bulltard,” but I think it is highly likely Apple grows its free cash flow at a greater than 6% rate for the next ten years.  It put in 35% growth for the past two.  That was down from 53.77% if you annualized the growth over the past six years.  So it’s slowing.  But to 6%?  Assume 10% growth and it’s worth $730/share.  Assume ten years of 17% growth, half what it did for the past two years, and it’s worth north of $1,100/share.

So I intend to engage in a little trader arbitrage.  My personal model, as stated above, is not so aggressive that it uses a 17% growth assumption.  I use a 12% annualized growth rate for ten years.  That is a blend designed to incorporate the idea that the five later years are likely to be much, much lower than the first five.  It is a bit more than 1/3 what Apple managed over the past two torrid years.  And it shows that at the HIGH this Spring, Apple only reached the top of my buy range, 20% below intrinsic value.

Look, this is not meant to be a comprehensive review of Apple.  I realize Microsoft is awakening.  I realize Google/Android is formidable.  I realize the carriers are going to want to reduce subsidies.  I realize the New iPad may not meet sales expectations.  I realize the expected TV might fail.  I realize there are recent whispers about carriers cutting subsidies.  But Apple has done so many things right for so long, that I am willing to give it the benefit of the doubt a bit, especially given what I consider to be a conservative buying assumption of growth.  So my first new buy point is at $560.  (This might get hit tomorrow.)  My next is at $500.  And if the traders are right and with their assistance the recent “parabolic move” retraces all the way to $430, then my friends the truck will get backed up.  And that will be trader arbitrage.**

*I’m not talking about losers trading 10 shares in their mom’s basement.  I’m talking serious, long-term professional traders that I do respect (though I will never emulate them) like @TraderFlorida, etc.

** Note I haven’t delved deeply into the quality of the components of the cash flows, but will before I actually buy.

Responding to Howard Lindzon. What will Apple do?

Howard Lindzon is obviously a whale and I’m a flea.  And he’s an intensely admirable whale, as a businessman, investor and blogger.  But Howard posted a blog last night about why Apple should buy Twitter that I think is totally wrongheaded.  The thesis is that dividends would be a horror for Apple (and Jobs, in his grave), and that Apple needs to buy Twitter in order to move “the needle.”  The catalyst for the post is Apple’s already-famous announcement that it will do a press conference tomorrow regarding what it is going to do with its cash horde.  The cash horde is presently at $97 billion-plus, about 60% of which is held overseas.  Here is the quote of Howard’s I find particularly wrong-headed:

As a shareholder I am quite happy that they have never given me the cash. How would I have done better than them to date.

Let me just say I believe the big announcement will be a special dividend, combined with some stock purchases and/or a tiny regular dividend.  But getting back to Howard’s post, I think it’s totally wrong to view the dividend money as an alternative to reinvestment in Apple’s growth at all.  Apple hasn’t grown using Howard’s theoretical dividend money!  Rather, Apple has grown using the money it actually needed to reinvest in its business, and Howard’s theoretical dividend money has been piling up in a savings account (or actually, in short term Treasuries and other cash equivalents)!  

So I think the post is just wrong.  The hatred that growth guys have of dividends simply astounds your humble Dumb Money correspondent.  Apple won’t be admitting that it can’t grow faster or continuously if it gives this money back.  Apple has already admitted that by saving the money up.  The least it can do is return something.  Because do you know what Howard, you probably could do better than Apple is doing in its savings account.

As far as buying Twitter, if Apple’s going to do a purchase, that’s not a bad idea.  But I think it’s questionable whether an investment even in Twitter is likely to generate the return on invested capital that Apple’s reinvestment in its own business does, either.

Howard’s connected, and I’m not.  So maybe he already knows that Apple will buy Twitter.  It would make sense in a way.  After all Microsoft just deployed a lot of its overseas cash horde by buying Skype.  Of course, as far as I know Twitter is actually legally domiciled in San Francisco, as well as headquartered there.  So Apple would not even be able to blow its overseas cash horde without paying full U.S. taxes on it.  Another reason Apple is in my non-expert view unlikely to buy Twitter.

Update:  I drafted this last night, and saved as a draft with the intention of posting today before “the news,” because this was my post for Monday.  And Apple went and announced its news before I could post it seems.  Nevertheless, I was essentially correct in my prediction, minus the special dividend.