Investors looking for stability should take a closer look at mega-cap stocks. These represent the market’s biggest companies, defined as stocks with market capitalizations above $200 billion. The number of mega-cap stocks in the market varies due to fluctuations in daily market values, but there are generally around 30 mega-cap U.S. stocks at any given time.
The appeal of mega-cap stocks is that they are typically leaders in their respective industries, with competitive advantages and long-term growth potential. They widely generate positive earnings-per-share, even during recessions, which allows them to return cash to shareholders through dividends each year.
Intel Corporation (NASDAQ:INTC) is one of our top-ranked mega-cap stocks right now. The stock is undervalued, having lost 17% year-to-date despite the fact the company has posted strong financial results throughout 2020. Meanwhile, Intel stock offers a 2.7% dividend yield and multiple catalysts for future growth, making the stock a buy for value and income investors.
Business Overview and Recent Earnings
Intel is the largest semiconductor manufacturer, producing chips for a variety of end markets. Intel dominates the personal computer chip industry, but also manufactures products like servers and storage devices that are used in cloud computing. Intel employs more than 100,000 people worldwide and has a current market capitalization of $208 billion. The company generates $70+billion in annual sales.
Intel has performed well in 2020, which is highly impressive given the extremely weak overall economic environment. On 7/23/2020, Intel released strong second-quarter earnings results. Revenue improved 19.5% to a second-quarter record of $19.7 billion, topping estimates by $1.2 billion. The company’s core PC-Centric business grew revenue by 7% to $9.5 billion. This segment continued to benefit from the work and learn at home requirements related to the COVID-19 pandemic as notebook sales more than offset desktop declines.
Earnings-per-share increased $0.27, or 29%, to $1.19. Earnings-per-share also easily beat analyst expectations, coming in $0.15 per share above estimates. It is especially rare for mega-cap stocks to exceed estimates by such a large amount, as mega-caps are more widely followed by the analyst community with more visibility into their financial results, making Intel’s second-quarter performance even more impressive.
However, the market completely ignored Intel’s strong results across its business in the second quarter, focusing instead on the company’s announcement that it will delay the release of its 7 nanometer CPU products. This product line will be delayed another six months, with current projections calling for launch in late 2022 or early 2023. Investors were understandably disappointed by the announcement, as Intel had already delayed the product line previously.
Shares of Intel declined more than 16% following the release of earnings results due to the delay. While some degree of negativity is understandable, as the 7 nm line represents an important part of Intel’s future growth, it is a mistake for investors to focus entirely on this disappointment. Long-term stock investors should focus on the company’s durable competitive advantages, strong business model, and steady dividends. If anything, the decline in Intel shares should be viewed as a long-term buying opportunity.
Growth Catalysts
Most investors likely associate Intel with personal computers, and given the company’s top position in the product category, this reputation is well-deserved. However, investors may view this negatively, as PCs are not reporting growth as a whole. Indeed, the PC industry is saturated, with growth having leveled off in recent years. But that does not mean Intel is not a growing company—instead, it continues to generate modest growth in the PC business, with reliable cash flow that supports investment in new areas.
At the same time, Intel’s growth segments including data centers, continue to rack up strong growth. Intel’s data-centric revenue grew 34%to $10.2 billion. Revenue in the company’s Data Center Group increased 43% to over $7 billion for the quarter, thanks largely to 47% growth in cloud service provider revenue. Another top-performing segment was memory, which generated 76% revenue growth last quarter and reached a record level of revenue at $1.7 billion.
Not only is Intel a tremendous cash flow generator—free cash flow totaled $10.6 billion over the first six months of 2020, an increase of 88% from the same six-month period in 2019—it is also seeing strong growth from next-generation products. This will allow Intel to continue investing in future growth initiatives, while also rewarding shareholders in the short-term with tremendous cash returns. Intel utilized $4.23 billion to repurchase shares over the first half of 2020. This reduced the company’s diluted share count by 5.4% over the first six months.
Share buybacks have a positive impact by boosting future earnings-per-share growth. As each share is repurchased, it makes each remaining share more valuable in the earnings-per-share calculation. On August 19th, Intel announced an accelerated $10 billion share repurchase, which by itself represents nearly 5% of the company’s current market cap.
Valuation and Expected Returns
Intel stock trades for a 2020 price-to-earnings ratio of 10.1x, based on current analyst estimates which call for full-year EPS of $4.86. We believe Intel’s valuation is too low, considering it is an industry-leading company with steady profitability, and multiple growth catalysts for the future. Our fair value estimate is a P/E ratio of 13x, which implies upside potential in the share price at the current level. If the P/E multiple expands to 13x over the next five years, it would lift annual returns by 5.2% per year in the interim.
Expected returns will also be fueled by earnings-per-share growth and dividends. We expect 5% annual EPS growth over the next five years, driven by revenue growth and share repurchases, while the stock has a 2.7% dividend yield. Putting it all together, we expect total annual returns of nearly 13% for Intel stock over the next five years.
Final Thoughts
The tech sector has once again led the market over the course of 2020, as it has for the past decade in the aftermath of the Great Recession. But not all tech stocks have outperformed. Intel is an example of a major tech stock that has lagged the broader market so far this year, and all because it announced a product delay. While investors were right to be disappointed by the delay, the market’s short-term pessimism seems overdone.
The long-term picture remains positive for Intel, given its dominant position in PCs as well as its multiple growth catalysts in data centers and the Internet of Things. With a low valuation and a 2.7% dividend yield, we view Intel as an attractive stock for value and income investors.