Microsoft, Intel Are Buys Ahead of Earnings

BOSTON (TheStreet) -- Tech goliaths Microsoft (MSFT) and Intel (INTC) are sitting on record cash balances and have delivered solid growth amid the recovery, but their stocks haven't matched expectations, including rave reviews from equity researchers. Intel is due to report second-quarter results Wednesday and Microsoft will release fiscal fourth-quarter results Thursday. The tech dividend stocks are attractive picks, even as growth tapers.

Analysts forecast that Intel, the world's largest chipmaker, will suffer a marginal decline in second-quarter adjusted earnings to 51 cents. They expect sales to have grown 19% to nearly $13 billion. Microsoft is predicted to have increased adjusted earnings by 12% and sales by 7.5%. With market capitalizations of $121 billion and $228 billion, respectively, such expansion is impressive, especially in light of sub-2% gross domestic product growth. Going further, Microsoft is the world's most powerful software company, with a wide economic moat, and Intel has lead market share in semiconductors. Their financial girth is apparent on balance sheets.

Corporate America has, quite literally, never been healthier -- in stark contrast to a government drowning in an estimated $75 trillion in cumulative debt and unfunded liabilities, including Medicare and Social Security. The fiscal uncertainty has investors unwilling to buy equities, despite historically cheap valuations, near-peak margins and efficiency and the aforementioned financial flexibility. This behavior looks increasingly illogical as mega caps such as Microsoft and Intel demonstrate that international growth prospects trump a tepid domestic economy. In sum, these blue-chip companies are still attractive.

Intel gets positive reviews, including "buy," "outperform" or "overweight" recommendations, from 61% of researchers in coverage; Microsoft gets 69%. At the end of its fiscal third quarter, Microsoft held more than $50 billion of cash, equivalents and short-term investments and just under $15 billion of debt, for just over $35 billion of net cash and a quick ratio of 2.5. A pending acquisition of Internet phone-company Skype should reduce net cash by $8.5 billion. The buyout has been applauded by researchers, who have been frustrated by the company's lethargy amid liquidity. Skype generated $180 million of unlevered free cash flow in 2010.

Microsoft plans to integrate Skype with its Xbox 360 gaming console, Windows phones -- which will be circulated widely due to a recent partnership expansion with Nokia ( NOK) -- as well as Lync and Outlook. Although Nokia is losing market share, the Windows phones will allow Microsoft to generate incremental software sales through its mobile operating system and increase its mobile search market share through Bing. Microsoft is making additional moves to satiate shareholders, including share buybacks and dividend growth. The company cut its float 3.8%, year-over-year, last quarter. The dividend has grown 17% in the past 12 months.

But, based on yield, with Microsoft offering 2.4%, Intel is a superior pick, paying a lofty 3.7% -- substantially more than the allegedly risk-free 10-year Treasury bill, which yields less than 3%. Intel's yield ranks seventh-highest in the Dow. The California-based company has amplified its distribution at an annualized rate of 13% over the past five years. Last quarter, Intel's gross margin widened to 75% from 74% and its operating margin stretched to 35% from 33%. Those spreads ranked in the 95th and 94th industry percentile, respectively. Intel recently closed its purchases of security-software company McAfee and Infineon Wireless Solutions, a wireless chipmaker.

JPMorgan ( JPM), recently named the overall best equity researcher on Wall Street by surveyor Greenwich Associates, has an "overweight" rating on Intel, calling it "The Hamptons of semis -- our favorite summer home." Given recent underperformance relative to its benchmark, normalized inventory and the best opportunity for earnings outperformance, Intel is JPMorgan's favorite play in the chip space. Recent cuts in PC sales growth have hurt the outlook for chip stocks, but Intel has reiterated its guidance in response to lower forecasts from key prognosticators IDC and Gartner ( IT). Macroeconomic headwinds remain a concern, though, for equity investors.

IDC now expects 4.2% PC unit growth in the second quarter, down from 7.1%, though Intel says third-party channel checkers are aren't accurately capturing global demand. While JPMorgan is bullish on this and next year, it sees full-year sales growth of 7.9%, coupled with a modest full-year earnings decline from $2.35 to $2.32. The stock's valuation is compelling. It trades at a trailing earnings multiple of about 10, or 51% less than its five-year average multiple. Investors are unwilling to pay up for mega-cap tech stocks. Intel's forward P/E of 9.3 and cash-flow multiple of 7.3 represent 29% and 68% semiconductor peer discounts.

-- Written by Jake Lynch in Boston.

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