Wintel: The Ugly Sister and the Buy of the Decade

September 7, 2011 • Posted by:

I challenge stock market investors  to come up with two tech stocks that are more unloved than Microsoft (NASDAQ:MSFT) and Intel (NASDAQ:INTC).

It’s not so much that investors hate the old “Wintel” duo (unless, of course, they are Apple (NASDAQ:AAPL) or Linux ideologues). No, “hate” would imply that they cared or even noticed the former tech darlings Microsoft and Intel.  Remember, love and hate are both intense emotions that are sometime hard to separate. The real opposite of love, as any spurned admirer knows, is indifference.

Investors are indifferent to Microsoft and Intel. With all the buzz surrounding the Apple iPad and its competitors, the Wintel platform seems a little stuck in the 1990s.

But in ignoring these two technology matrons in favor of chasing the new tech “it” girl, investors are making a classic mistake. Recall the movie A Beautiful Mind in which Russell Crowe plays the eccentric (and, unfortunately, schizophrenic) economist John Nash.  In explaining the Nash Equilibrium in layman’s terms that the average movie goer could understand, Crowe used the analogy of a group of men in a bar all competing to win the affections of the prettiest woman.  In this scenario, one man might indeed succeed in getting her phone number, but the rest will not.  The more optimal outcome would be for each of the men to approach a different one of her slightly homelier friends. The odds of dating success increase for all.

Though somewhat crude, this is exactly how value investing works.  When investors all pile into the same glamor stock, the price gets bid up to the point that no one buying is likely to see good results.  But the stocks that fail to attract attention — the less attractive sisters — are often priced to deliver good returns, particularly if they pay a respectable dividend.

Intel and Microsoft were glamor stocks a little over a decade ago.  Both had price/earnings ratios of well over 30 in 1999, and neither paid much in the way of dividends. Not shockingly, both performed phenomenally poorly as investments in the time that has passed. Microsoft now trades for less than half of its old all-time high, and Intel trades for barely a quarter—and this despite Microsoft and Intel both seeing their earnings per share more than double.

It’s no wonder that investors grew indifferent to Microsoft and Intel.  But that indifference has created a fantastic buying opportunity.

Microsoft and Intel both have single-digit price / earnings ratios and sport dividend yields of 2.4% and 4.2%, respectively.  It should be noted that both yields are well above that of the 10-year Treasury note and that unlike the Treasury note, the payout of both companies is almost guaranteed to grow over time.

And lest anyone think that these low valuations are due to lousy operating results, both companies have enjoyed robust sales growth and high returns on equity.  While Intel’s ROE is respectable at 25.9%, Microsoft’s is eye-popping at 44.8%.

Microsoft has had a hard time expanding beyond its core Windows and Office markets, but that’s ok.  At current prices, even if all of Microsoft’s new endeavors prove to be failures—including its purchase of Skype and its partnership with Facebook—the company is a bargain at current prices.  And if any of these projects actually pay off, Microsoft stock is the steal of the decade.

The same is true of Intel stock.  While I fully believe that the company will make major progress in the mobile market (where it is currently weak), at current prices it doesn’t matter.  If Intel never successfully expands beyond its core PC and laptop markets, the stock is still a bargain.

“Wintel” is not sexy, and it hasn’t been sexy in over a decade.  But investors wanting a respectable and safe return on their money in the next decade should think twice before leaving her alone at the bar.

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  • http://thereformedbroker.com Josh

    I hear ya on the cheapness, but you could have made an identical argument in 2006,2007, 2008, 2009, 2010 and probably you’ll be able to write the exact same post in 2014

    just as one shouyld never short a stock solely on valuation, one should probably not be buying one on that basis alone either…see these stocks are cheap because they are dead money without a single conceivable catalyst on the horizon

    They should both be yielding 4% but they are stubbornly clinging to their “tech growth stock” status.

    I want to like them as much as you do because of how unloved they are, but I cannot see anything that can move them higher, what am I missing?

  • Charles Lewis Sizemore, CFA

    Josh,

    Your point is well made. Intel and Microsoft have been cheap for a while and getting cheaper. As former growth stock darlings, it has taken the better part of a decade to wring the excesses of the dot com bubble out of their prices. I agree that both should yield higher than the market averages (and both do), though only Intel is above 4%.

    For me, the impetus that will send these stocks higher is the exhaustion of all other options. Investments go through fads, and the last decade has favored energy, materials, precious metals, and select social media stocks. As these trends run their course, investors will eventually shift into old-line tech and other established blue-chips. “Eventually” may be today, or it could be a few months down the line. In the meantime, we’re getting paid to wait. In this interest rate environment, 2.4% and 4.2% (and growing) isn’t half bad as a cash return.

    CLS

  • Mark Swanson

    I agree with Charles. You can’t win at value investing unless you are willing to wait. The best and most successful value investors often have big positions that have done nothing in first year or three since they bought in. And sometimes, you are going to be wrong and have to take the loss. But in the long run, value has always outperformed.

  • Starman

    So if I understand you correctly, you are actually suggesting a Buy and Hold strategy. Last I checked, it didn’t yield great results.

  • Charles Lewis Sizemore, CFA

    Starman,

    It’s all about the price you pay. “Buy and hold” is a fine strategy so long as the investment in question trades at a reasonable price and (preferably) pays some current income. Few tech stocks would have fit that description 10 years ago, and Intel and Microsoft were no exceptions. Both sported nosebleed valuations, and Microsoft didn’t pay a dividend at all.

    So yes, I would agree that a naive buy-and-hold strategy irrespective of price is a poor investment strategy. To everything there is a season.

    CLS