Monday, August 8, 2011

Sprizouse's August Stock Promotion

The stock market has been hammered over the past week, which usually means its a good time to buy stocks. And since I haven't promoted a stock since picking KapStone Paper and Packaging Corp. back in June, I thought it was time I publicly made another recommendation.

My pick for August is Intel Corp. I chose Intel solely because I was looking for dividend paying stocks that have high upsides. I tried to stay away from the more volatile tech stocks, but nevertheless Intel still made the cut and I'll get into their full report below, but first I want to review KapStone.

KapStone outperformed the market for most of July, but came crashing back to earth when the overall market crashed. It currently sits at $12.90 which is down $2.08 from the price at which I made my original KapStone stock pick ($14.98 on June 13). That's a loss of 13.9% since making the recommendation, and for comparison's sake, the S&P 500 is down 11.9% since June 13 and Alcoa Inc. (the stock I originally compared to Kapstone) is down 25.9%.

KapStone's performance obviously hasn't been great, and it hasn't even managed to stay ahead of the market's losses, but I didn't recommend the stock for short-term pops or for people looking for trade to make a quick buck. It was (and is) a long-term recommendation and I still stand by it in that respect (which is not much consolation for those of you holding the stock right now).

As for its quarterly report? Well, KapStone released second quarter earnings last week, and everything from the earnings report is basically in line with what I wrote in June. The firm is on pace for a 10-to-15% increase in revenue for 2011 and should beat their overall net income from last year rather easily. Their year-over-year net income doubled last year's June numbers, but that was to be expected as I noted before, from the price increases they instituted. KapStone hasn't taken on any other debt and they've managed to lower some of their operating costs even as they've increased in revenue. So, in short, nothing's changed with my KapStone recommendation from June. It's still a great stock and it's still a great stock to buy for any portfolio that wants to go long small-cap stocks or small-cap manufacturing or paper companies.

Now, before I get into the Intel recommendation, I'd like to make a brief aside to talk about the market in general. Yes, stock markets have plunged recently. But that usually means its a good time to buy stocks and sell bonds. And there also might not be any real economic, or fundamental, reason for equity markets to tank so horribly the way they have in the past week.

However, we are dealing with a very weak domestic economy, a very weak European economy (coupled with default fears in European periphery) and it appears the Fed and the federal government won't be doing much to intervene here (although its possible the Fed moves to institute QE III, as ineffective as that may be, it would still be something. And in Europe the ECB seems willing to step in and help in Italy, but all these are bandaid, reactionary-like measures rather than attempts to fundamentally stimulate demand). So we can probably expect equity markets to remain flat for the next year or two (at minimum) because demand isn't going to suddenly materialize out of nowhere, so there really is no end in sight to the recession no matter how rosy any macroeconomic forecast looks. Therefore, any large upswing (like the two-weeks-long rally in July) will probably be followed by a corrective downswing. And if you operate under the assumption that equity markets will remain flat for the foreseeable future then, as I mentioned before, it's reasonable to assume that now is a good time to buy.

Which brings me to my pick for August.

I was looking for any recommendations for sectors or for any particular stock that friends or family wanted me to analyze. I was asked for a recommendation to find a really good dividend paying stock. The question came from a conservative investor who prefers going long dividend-paying stocks and after nearly a week of research I came up with Intel.

I did everything I could to stay away from tech stocks because the tech sector is usually a more volatile sector as technology can, and does, change rapidly. But then again, as fast as technology changes, almost all tech companies will need processors of some sort to run their new consumer software or hardware -- think iPads, iPhones, super-thin laptops and what have you. At this point in the game Intel and AMD are the two main companies dominating this sector (yes Sun, IBM and NEC are in the mix, but for the most part, Intel and AMD lead the way). So if you're not afraid of tech stocks and you're looking for a dividend-paying stock, then look no further than Intel.

Intel currently just announced a new quarterly dividend for the third quarter (to be paid on September 1) of $0.21 per share (the stock just went ex-dividend on Friday, so if you buy now you're not going to get the dividend payment in September).

The dividend payment annualizes to $0.84 per share which (at Intel's closing share price today of $20.11) means they're currently paying a 4.18% annual dividend. For a tech company that's growing, and for a company that still has room to continue to grow because it's going to be providing microprocessors and chipsets to everybody's new iPhone, iPad and laptop for quite a while? Well, a 4.18% annual return on dividends alone, for that kind of a firm in that kind of industry, is really good.

So let's get into the fundamentals of why Intel's a good buy and see what we can see.

First of all, let me say that Intel isn't without issues. The company and the stock are not experiencing the same levels of production (percentage-wise) that a company like KapStone is. But that's to be expected when you're a much larger, dividend-paying company -- growth prospects tend to decline linearly with firm size.

Also, part of the reason that any company elects to start paying a dividend is that management doesn't see a need to retain a horde of extra cash to remain nimble and able to respond to any currently unperceived market threats. The company also doesn't see a comping period of high growth which means they won't need to reinvest excess cash back into the business and, say, build more manufacturing plants, spend more money on advertising or hire more workers. Therefore, growth rates and other growth measurements and components (like return on equity) tend to be lower with a dividend-paying stock than with a non-dividend paying stock.

So let me discuss the problems. First of all, Intel showed a spike in its overall level of leverage in last year's 10K. Specifically the leverage spike showed up in its accrued compensation, accounts payable and other accrued liabilities accounts. When most people look at a firm's leverage they tend to only look at levels of debt. But accounts payable and accrued compensation are really no different. They're just a different form of credit. The firm has basically received credit terms from a supplier (in accounts payable) or from employees (accrued compensation) and those accounts, just like any loan or credit taken from anywhere else) will eventually come due.

Last year, Intel showed a $1.2 billion spike in those three accounts. That's not a great sign for earnings going forward as it means the company could have under-reported its expenses by $1.2 billion last year. And even if there wasn't any conscious effort to under-report those numbers, that money will still come due this year or next and will have to be expensed away (therefore dropping 2011 or 2012's earnings by that amount).

But Intel is a big enough company to get away with moving $1.2 billion around using discretionary accounting measures. To most mere mortals $1.2 billion is a monster number in absolute terms, but Intel's assets are $63 billion, and yearly revenues were $43 billion last year. So moving around $1.2 billion won't affect balance sheet or income statement ratios as much as you'd expect. However, if this were occurring at a smaller, less-established company, it might have been enough to scare me away. But, as of last year, Intel was sitting on $17 billion in cash and another $5 billion in short-term investments (which it had remaining after it paid out $3 billion in dividends). So Intel still has $25 billion in excess cash sitting around and you'd expect that when the $1.2 billion in accrued expenses comes due, it won't hurt net income and won't force the company to lower its dividend payment either.

Speaking of the cash on hand: Intel's revenues and net income have improved dramatically over the last two years and should do very well in coming years which is the primary reason its got so much cash on hand. And all that cash will eventually have to go somewhere, so I'm assuming that their dividend payments will continue to rise next year (I actually calculated that the company would raise its quarterly dividend payment at some point this year while doing my analysis in July, before Intel made the actual announcement a few weeks ago).

The firm, in no small part due to its Sandy Bridge processors (which are being used in all those gadgets I previously mentioned), has also increased its profit margins to record levels. Their asset turnover ratio has remained steady (and strong) which means the company's overall return on equity for 2010 was its best in five years (2010 ROE was 23.1%, the last time it was that high was in 2005).

In all, the fact that Intel has been crushing the competition and generating record revenues in the teeth of the Great Recession bodes well for its medium-term future. And the fact that Intel's success over the past two years has allowed it to pile up a hoard of cash bodes well for investors and dividend investors.

Nothing in Intel's accounts jump out as scary negatives beyond what I've already mentioned. Their accounting looks legitimate across the board with low levels of accruals and solid earnings. The stock looks underpriced for one that pays a 4.2% annual dividend and the company has a solid buffer against any unforeseen economic events or problems with so much cash on hand. Therefore if no disastrous economic problems materialize in the near future (I can't make any promises we won't have a seriously bumpy ride in the near-term), then Intel should be able to sweep away that $1.2 billion without blinking and investors should expect them to continue paying out strong dividends and performing above most.

(Full disclosure: I hold no positions in any of the stocks I've mentioned in the post. Also... if you're taking stock advice from a random guy on the internet, its probably a good idea to reexamine your overall investment strategy). 

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