In September, I challenged readers to come up with two tech stocks that are more unloved than Microsoft (NASDAQ: $MSFT) and Intel (NASDAQ: $INTC)—see “Wintel: The Ugly Sister and the Buy of the Decade.”
As I wrote in September, it’s not that investors hated the old Wintel duo. “Hate” is reserved for more recent fallen stars like Netflix (Nasdaq: $NFLX), which we’ll return to later. No, investors were indifferent to Microsoft and Intel. In the era of smartphones and iPads, Microsoft and Intel seemed a little like buggy-whip makers in the age of automobiles.
There were two major problems with this line of thinking. First, both stocks were incredibly cheap, trading at single-digit P/E ratios and yielding more than the 10-year Treasury note. Secondly, both remain wildly profitable and continue to post record earnings.
Intel knocked the ball out of the park last week with its third-quarter earnings release, sending its share price up sharply. Company profits were up 17 percent over last year, setting a new record of $3.47 billion, or 65 cents per share.
I believe that Intel will eventually come up with a worthwhile chip product for tablets and smartphones. Or if not, they’ll buy someone else’s design. But even if Intel never successfully breaks out of its core markets—and even if the company’s growth rate ground to a halt tomorrow—the stock would be cheap at current prices. In fact, Intel could rise by 50-100 percent and still be cheap given the safety and quality of the company.
Ignore the drone of self-proclaimed tech experts that tell you the PC is dead. iPads are great, and the market for tablets is expanding faster than the market for desktop and laptop computers. But Intel’s results should be proof enough that the PC market still has quite a bit of life left in it. Intel trades for 9 times forward earnings and yields 3.6 percent. Intel is a buy.
Microsoft, the other half of the Wintel duo, also released earnings last week. Earnings were up a respectable 6 percent, matching analyst estimates. Diluted earnings per share were up 10 percent. Interestingly, the Windows franchise broke a three-quarter slump, showing modest gains in sales of the operating system in the last quarter.
I might add that Microsoft was able to post these gains in a sluggish economy with the highest unemployment in 30 years. Cash-strapped businesses and consumers aren’t exactly queuing up to buy new computers, choosing instead to get a little more wear out of their existing equipment. That Microsoft is able to grow its sales and profits in this environment is testament to how essential its products are in the modern world.
Microsoft, like Intel, finds itself in the position of having to convince investors that it is still relevant in the age of the iPad. PCs just aren’t cool anymore.
The company has collaborated with Facebook and has begun to incorporate Skype into its products (and into Facebook too, for that matter). But thus far, Microsoft has come across looking like high school mathlete geek desperately trying—and failing—to fit in with the popular kids.
I’m ok with that. As a contrarian investor, I prefer to buy companies that are distinctly uncool. It is the unloved and discarded stocks that offer the best returns to investors patient enough to wait for the whims of the investing masses to change. In the case of Microsoft, we’re getting paid handsomely to wait. The company recently raised its dividend by 25 percent and currently yields just shy of 3 percent. Given that this is more than you can earn in the bond market, I’m content to wait indefinitely. We’re still making a decent return is a very rough market.
Chasing trendy stocks is a risky business. Consider the case of Netflix Earlier this year, the former growth stock darling could do no wrong. The company that put Blockbuster into bankruptcy with its DVD-by-mail business was aggressively expanding its internet streaming offering. But why anyone would pay a premium multiple for the stock was a mystery to me. The company had no competitive advantage, or what Warren Buffett likes to call “moats.” There was absolutely nothing to stop a well-funded rival from offering the exact same product, and there was already a small degree of overlap with the streaming site Hulu. And Netflix was also completely at the mercy of its content providers, the movie and TV studios. Given the slow growth plaguing all media businesses these days, it was only a matter of time before the studios demanded a bigger slice of Netflix’s profits.
Let me be clear on something: I like Netflix. I am a customer myself, and I believe that the company’s streaming service is the future of TV. But there was so much optimism baked into the share price, I couldn’t even consider buying it or recommending it in this newsletter. Even today, after falling by more than 60 percent from its high, the stock is still expensive. It trades at nearly 30 times trailing 12-month earnings and 18 times estimated 2012 earnings. And given the number of customers the company is losing in the aftermath of their botched divesture of the DVD-by-mail business, those earnings estimates may prove to be overly optimistic.
I bring all of this up not to bash Netflix and its management but rather to make a point. When it comes to investing, you don’t want to be trendy. Yes, you can make a boatload of money in a hurry. Plenty of instant millionaires were minted during the go-go days of the 1990s dot com boom. But when you invest in what is currently trendy, you are playing a risky game of musical chairs. It can be a lot of fun…until the music stops and you find yourself without a chair.
When you buy a stock that is unloved and cheap, there is always the risk that it becomes more unloved and cheaper. But if I’m paying a reasonable price and getting paid handsomely in cash dividends to wait, that is a risk I’m willing to take. At current prices, Microsoft and Intel remain the buys of the decade.
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