The great thing about being a bellwether is that the slightest hint of something good has the power to drive up not just your stock but your entire sector, or even to boost the market as a whole — as Intel's improved forecast did on Friday. Unfortunately for investors, that's also the downside of paying too much attention to even the smallest change at a behemoth like Intel: those changes can spark an over-reaction, particularly when good news in technology seems to be a fairly rare commodity.
The news that Intel was raising its target revenue range to between $7.3-billion (U.S.) and $7.8-billion — from an earlier target of $6.9-billion to $7.5-billion — sparked a strong upward move not just in tech stocks but on the entire Nasdaq Stock Market, in what one CNBC commentator called "a veritable tech love-fest." Earlier in the day, Intel itself climbed by as much as 10 per cent on the news to over $29, and in early trading the Nasdaq was up by almost one and a half per cent. (The Nasdaq was slightly negative and Intel shares were up 6 per cent in late afternoon trading.) That took it over the psychologically important 1,800 mark, a level the tech-heavy index hasn't seen since early last year.
Intel's stock is also at levels not seen since the spring of 2002, when it was selling for more than $30 a share. Not long afterward, however, investors got a nasty shock when the chip-maker cut its estimates, saying demand was not meeting expectations, and the stock fell from the $28 level to a low of just $12.95 in October. Investors who have gotten a warm and fuzzy feeling from the chip giant's latest forecast might want to note that Intel's stock has already come a long way from that low point. It has more than doubled, in fact, based on the market's expectation of improved results.
In other words, much of what Intel is telling the market now about higher revenue and higher profit margins is arguably already "priced in" to the shares, or taken for granted. Based on its profit and revenue over the past 12 months, the stock is selling for close to 50 times earnings and more than 6 times its sales per share — nosebleed valuation levels even at the best of times, and these are not the best of times. They may not be the worst of times either, but there is still doubt about how quickly the PC market, Intel's bread and butter, will be able to grow over the next year.
Even based on profit forecasts from a majority of analysts, Intel is far from cheap. It is selling for more than 40 times its projected profit for the current year and more than 30 times consensus forecasts for next year. And yet, Intel gets more than 80 per cent of its revenue from the personal computer market, which most analysts expect will grow at a rate of perhaps 8 per cent over the next couple of years. Even if you assume that Intel's market dominance will allow it to grow much faster, the current price-earnings ratio is still more than twice that projected growth rate.
It's worth noting as well that Intel's targets — as always — contain a significant amount of "wiggle room." This latest revision to the revenue range for the third quarter could produce growth as low as 12 per cent over the same quarter last year, or as high as 20 per cent (and that is also compared with what was a weaker than normal third quarter in 2002 as a result of a number of factors). The forecast for gross profit is that it could be as high as 56 per cent, "plus or minus a couple of points" from the previous target of 54 per cent, plus or minus a couple of points. And that is the company's gross profit, before all of its various expenses, not the operating or bottom line profit margin.
Brokerage firm Oppenheimer & Co. also pointed out in a report last month — after Intel came out with the original gross margin target of 54 per cent — that some of this improvement was a result of the chip company reclassifying certain costs as research and development expenses. As the analyst noted, this change improved gross margins but would not improve operating profit by a similar amount. In other words, Intel will not have significantly more in operating cash flow than it did before the expense change. Some of the margin improvement was as a result of higher revenue, the Oppenheimer report said, but not as much as it might seem on first glance.
None of this should take away from the fact that higher revenue at Intel is a good sign of a possible approaching recovery in technology. But that recovery still remains a possibility rather than a certainty, as even Intel CEO Craig Barrett himself noted in his comments Friday, saying demand was "spotty" and that it was too early to say a recovery was under way. And yet Intel's stock is trading as though it is all but a done deal. At $12.95 last October, Intel was obviously trading below its potential, but have things improved so much that it should sell for more than double that, and more than 30 times even optimistic estimates for next year's profit? In a word, no.
E-mail Mathew Ingram at mingram@globeandmail.ca
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