November 2024 Issue 6
RATIONAL REFLECTIONS By Bell Institutional
The Penthouse vs the Outhouse In September, we covered how an investor can use stock prices and the concept of thinking backwards to obtain better investment performance. We argued that stock prices can be used to gauge the market’s current expectations for operating performance. With defined future expectations in hand, an investor then can determine whether those expectations are likely to be met or not. To expound on this concept in further detail, we will compare Intel, a company that has lost investor favor, with Nvidia, a company that is the darling of AI.
Potential Turnaround or a Sour Grape? A Look at Intel’s Future Prospects Much has been made of Intel’s fall from grace in recent years, given its former place at the top of the mountain. The company has faced criticism for its product roadmap, manufacturing challenges and perceived lack of innovation. As a quick background, Intel was founded in 1968 and quickly became a pioneer in the microprocessor industry. Intel developed the x86 central processing unit (CPU) in the 1970s that emerged as the instruction set required for IBM PCs and, later, Microsoft operating systems. For many years, effectively all PC software was designed for the x86 architecture, and software makers could not easily deviate from building x86 optimized applications. Intel’s dominance was further solidified by its adherence to Moore’s Law, which states that the number of transistors on a microchip doubles approximately every two years. This allowed Intel to consistently release faster and more powerful processors, maintaining a significant technological advantage over competitors.
Given Intel’s then lead in manufacturing capabilities, customers often were forced to “take it or leave it” when buying chips. Unfortunately for customers, they didn’t have much of a choice. This inability to work with customers came to a breaking point in 2005, when Intel lost out on (or passed on, depending who you ask) building chips for the iPhone. Intel’s revenue growth has been sluggish since the iPhone debuted in 2007, with an average of 2.7% annually. However, the factor recently driving Intel’s price downward has been its manufacturing miscues,¹ which have resulted in margin compression. Specifically, operating margins started to fall off a cliff in 2022 (ChatGPT was released in November 2022) as the company has been unable to effectively ramp production for its AI products. Intel’s second-largest segment is Intel Foundry, which physically manufactures semiconductor chips. A foundry incurs large fixed costs which result in high amounts of leverage. If a foundry does not have sufficient 1