Intel Is Last Cycle's Story

Price is everything when buying stocks. And the price of IntelINTC stock, even though it's off 70% from its peak in 2000, is still too high and fraught with risk.

Any look at valuation has to start with earnings, and it's obvious that Intel hit a sweet spot in the last cycle when it generated record earnings in 1999 and 2000. Those earnings, though, were not of the highest quality.

Investment gains contributed 8% and 25% to pretax income in '99 and '00, respectively, with Intel's net profit margins jumping from the low 20s to more than 30%. But most of those gains were generated by irrational tech valuations, and with the current difficulties in the industry, it's clear that the inflated profit margins of '99 and '00 won't be back anytime soon.

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Let's consider some key points.

Best-Case Scenario

Assuming net profit margins have bottomed at the current 12% to 14% level, the absolute best-case scenario for Intel would be for profit margins to return to the 24% level, the five-year, prebubble, average net margin for the company. This is highly unlikely for several quarters, given the weak demand picture in most of Intel's end markets.

But let's get wild and assume Intel can return to 24% profitability next year, and on a very optimistic revenue base of $28 billion. The best-case net result then would be about $1 a share in 2002 earnings. Because the current quote for Intel is about $24, that means it's trading at a hefty 24 times next year's earnings, too high a multiple for the most optimistic earnings scenario.

Also keep in mind that the five-year average price-to-earnings ratio for Intel, prebubble, was 12.5. Apply that P/E to the optimistic (and unrealistic) earnings level of $1 a share for 2002, and investors will understand why capital invested in this $24 stock is clearly at risk.

Intel does have a ton of cash -- netted against all liabilities, stated and unstated, including capitalized leasehold commitments, the company has about $8.5 billion in cash. But that does not provide a wide margin of safety for investors because it amounts to only 6% of Intel's roughly $140 billion market capitalization .

Yesterday's Story

A final reason to avoid Intel stock is because it's yesterday's story. I'm convinced that the stars of the last cycle, including companies like General ElectricGE, MicrosoftMSFT, DellDELL and Intel, are not going to be the leaders of the new cycle.

Institutions and others simply have too much exposure to these companies. They are overowned, overloved and overpriced. And the next cycle is not going to be led by $100 billion-plus companies priced at 25 P/E's and higher.

I think the new cycle will be about finding value in small- and mid-cap companies. Some of the companies that I have recommended in prior columns continue to trade at large discounts to business value, such as ManpowerMAN, Raymond JamesRJF, Legg MasonLM, Circuit City CC, Liz ClaiborneLIZ, SafecoSAFC and Office DepotODP.

Who won today's Face-Off? Glenn Curtis Arne Alsin