Friday, January 15, 2010

January 15, 2010

MrArbitrage on Wall Street & Intel: "This one goes to eleven"

Marketwatch featured a column today regarding the fall of Intel’s stock price in spite of beating the consensus in a strong quarter. The concern is that although Intel is executing perfectly, they may be “peaking” and there are signs that margins are eroding.

The column is full of statements like “analysts had expected…” “analysts currently project…”

There’s the problem right there. Although I’ve been in this industry of “Wall Street” for a long time, it got me thinking - why even have analysts when all of these companies provide such guidance? Who knows better of what to anticipate than the people running the company? And the executives seem to be held to more scrutiny than the analysts. How many Wall Street analysts do you see going away in handcuffs versus CEOs? I laugh when I see the numbers analysts “expect” versus the company guidance because it’s usually within a few cents. I would LOVE to see how FAR OFF Wall Street analysts would be if they were not given guidance from these companies. I would love to see their raw due diligence and how they came to their numbers (I’m smirking).

It’s a farce. I mean, we all know the companies like to under-promise and over-deliver so they can “beat expectations” – but I think we are smart enough to figure that out and just round up a few cents to come up with our own expectations.

It reminds me of a scene from the cult classic film “This is Spinal Tap” where "Nigel", the metal guitarist is showing off his custom Marshall amplifier to the interviewer (played by Rob Reiner). In this scene, Nigel boasts about how most amplifiers only go to 10, while -his- "goes to 11". Reiner asks “Nigel” the question “why not just make 10 louder and make 10 be the top number?” Perplexed, Nigel pauses and answers “but this one goes to 11”. (Here’s the scene if you haven’t seen it.

This scenario is analogous to Wall Street analysis. Why not make the template adjustment to the corporate guidance yourself instead of paying an overpriced analyst’s salary? The answer to this rhetorical question is that they create an illusion of complexity that helps sell their services.

One of the quoted analysts wrote "Although we believe Intel is executing flawlessly, we are seeing several signs of a peak in the stock in terms of gross margins and earnings,.

I wrote a piece eight years ago on Intel that is relevant to this situation:

DATE: 1/16/2002 TITLE: “To the Pollyanalysts” (time-stamped verification)

"Letter to the Analysts":

It's a tragedy that people still listen to you charlatans. Do earnings mean anything to you?
Does market cap mean anything to you?

When a company like Intel has its earnings drop 80% and it is still priced not for perfection as some like to say, but rather for stupidity, what do you do? You stick to your guns in order to save face and declare it a strong buy! It is typical of human nature to mitigate as you do in order to save face; however, it is disgraceful when your saving face is at the expense of millions of people. With INTC currently near its 52 week high and a market cap of about $240 BILLION DOLLARS, Intel will need to reach a market cap of about $1 trillion dollars in order to live up to the premium by which it now trades.

If Intel's near term future was so rosy, they would be increasing capital spending - not decreasing it. They should also be pumping up R&D spending because they are going to need to open new industries if they are going to reach the new highs from here which you predict. The actions of Intel don't seem to match the zeal priced into the stock, after all, as I have been challenged over the past several months for propounding the notion that the nature and history of technology is attrition in profits and margins despite the improvement of technology, the contention was that Intel would spend money fervently in order to create new markets. That was the justification I was given for such an extraordinary premium for diminutive earnings.

It will be absolutely necessary for Intel to re-invent itself to warrant this price because during their glory years, most people didn't yet own computers so naturally sales would be quite strong. It was the same way with automobiles, radios, televisions, VCR's etc.

The Calculator business was once a highly profitable growth industry. Now that so many people already own computers, there needs to be a pretty compelling quantum leap in technology for most people to keep that extraordinary growth rate of the 1990's going.

There is no such incentive at this time. Unfortunately, Intel is priced at the 50% EPS growth rate at this time while growth rates have actually been receding by the double digits! The price doesn't make sense.

I'm not saying that Intel is a bad company. There is nothing wrong with Intel. There is something wrong with Intel's price. I might add that it is through no fault of their own, unless Arthur Andersen is doing their accounting. The current egregious error in Intel's price in my opinion is directly attributable to the charlatanism of the Wall Street analysts coupled with the excessive credulity of the investors and fund managers. I believe we have a castle in the air my friends. Remember $240 BILLION Dollars is a lot of money, even in this day and age. In order to be willing to pay $240 bills for this company, one has to believe that Intel is heading to at least a half of a trillion dollars in market cap while jobs continue to be obliterated...

As I predicted in December, the new wave of cuts are coming after the major new cuts in automotive firings. We are in recession. Unemployment is going to the double digits and there is no compelling technology out there to start a massive wave of upgrades in tech spending.

So, all of you pseudo-analysts out there, sit back and have another hit of the old peace pipe."

In retrospect, not only did people scoff at my Intel price target, they also ridiculed my double digit unemployment prediction.