Intel was the best performing Dow stock during October helping to propel the index to a 4% return during the month.* Due to an exceptional quarterly report, the company has garnered new love from Wall Street with many analysts jumping aboard the bull train and institutions clamoring to add the once-beloved tech favorite back into their portfolios. By now, you may be aware of my long-held love for the stock.   So, it should come as no surprise that I desire to discuss the recent actions and provide my own color commentary.

See Also: Intel Thoughts (October 19, 2016)

No, this is not a chest-thumping rant, but rather a humble review of the patience and fortitude it has taken to remain long this name, well before the sentiment recently shifted. Furthermore, it is also worth noting that one cannot ever become complacent in their investments as facts can change; thus, my opinion regarding the direction of the stock can change and may warrant immediate action. While at the same time Intel was, once again, becoming a fan-favorite, we were forced to take a stop on our beloved pharmaceutical stock. There will always be winners and losers, but we must always aim to cut losers quickly and let the winners work.

For years, the analyst community and Wall Street, in general, has had an issue with the way in which Intel deployed its outsized cash position. This, in itself,  I find fascinating. Any company generating so much cash that it is forced to make tough decisions on where to allocate this cash is intriguing, as this is a fantastic problem to have. Let us not forget that it was many of the same Intel managers who made decisions in the past which resulted in this outsized cash – but I digress.

While many approached Intel regarding their qualitative opinions surrounding its use of free cash-flow, I did not venture down this opinionated path but rather focused on my favorite quantitative metric for determining whether or not Intel’s deployment was successful.

Return on Equity is simply a company’s net earnings divided by its total equity value or, better stated, a stock’s earnings per share (EPS) divided by Book Value or (BV). This number represents the return a company is generating within its business. For example, if a company has a per share book value of $10.00 and generated $1.00 in EPS, we could say that its return on equity is 10%. This is decent, considering a 10% return per year is difficult to find in any environment. If, however, the company’s EPS was $2.00, it would result in an ROE of 20% which is, by anyone’s standards, pretty darn solid. As a side note, there can be some tricky caveats to consider here as companies can play some serious accounting games.  For many companies with little to no debt, ala Intel, it’s a pretty safe indication of how they’re doing in deploying their capital. Intel has averaged a 19.4% ROE over the last 5 years and a 18.92% over the last 10.** It’s pretty easy to say this company is doing just fine deciding where to invest its cash.

Despite the general opinions of Wall Street to the contrary, my analysis and review of Intel’s return on equity told me it was, in fact, being very prudent with its capital and was generating solid returns within the company. Therefore, my belief was that it should be just a matter of time until this became so apparent to the investing public, investors would be forced to change their tune.

This is exactly what happened when the company posted such an incredible quarter that analysts had to step up and take notice, as illustrated by the numerous analyst price target increases the morning after. It has been my experience that, after a while, when a company continues to do something right for so long, it is inevitable that Wall Street wakes up to that fact and makes rapid concessions.

There are a few takeaways from this experience that I want to draw on, and things I believe we can learn. First off, it is important for us to get ‘paid while we wait.’ This phrase refers to the dividend that was being paid (3%+) while we patiently waited for the stock to wake up and show us an appreciable move. While not mandatory, favoring stocks with strong and healthy dividends definitely helps with the patience – at least for me. Second of all, it is critical to keep the position size well within a prudent limit so that, if my analysis was wrong and we were forced to step aside, we could do so without significant collateral damage. Intel was added as a 5% position in our Aggressive model, pro-rated down for Moderately Aggressive and Balanced. When it was purchased it had around a 10% stop loss, which means that should we have been stopped out at that level, an aggressive portfolio would have suffered a loss of 0.50% to the overall portfolio value. To me, this has always seemed like exceptional risk-reward and worthy of our capital.

It was not enough to just ‘assume’ our analysis was correct but, rather, we wanted to see the financial progress first hand.  During each quarter, we measured the company’s progress to be sure our researched-based opinion still stood firm. Despite stagnation in the stock price, it was my opinion management continued to execute well and quarterly financial reports continued to improve.

While at this current price we will no longer be buying Intel for new clients, we have no intention of selling this position for existing clients. It is our opinion that this move has just begun. Hopefully, the stock will correct in the future and offer us a prudent entry point for new clients, so if you’re just joining us, don’t fret, we will work hard to find a prudent entry into this company for you in the future.

Now that other investors have adopted the thesis we’ve held for so long, our job is to sit back, wait patiently, hoping the herd takes our beloved Intel from what we see as undervalued, to fully valued and well beyond overvalued. It will be at this time when we will look to part ways and move on.

While the rest of the world is pounding the drum for index investing, I continue to find it difficult to allocate money into a basket of stocks which look to be trading in the stratosphere, when there remain individual companies which appear to us to possess a better value, if one is willing to put in the work and dig for opportunities.

Until next time

~ Quint

** Value Line company fact sheet dated 9/29/17