Streetwise

Lauren Rudd

Sunday, October 17, 2010

Fear and Greed Continue As Always

Recently there has been a resurgence of concern over whether fear and greed are once again taking hold as the driving force behind the gains on Wall Street. I hate to mention this, but when have they not been the driving force?

You need to accept the fact that Wall Street is what it is; keeping in mind that the desire for a quick profit can often result in short-term behavior that is both unexpected and unpredictable. This was well demonstrated during the May 6 “flash crash.”

Subsequent inquiries into the crash dwelled on the legitimacy and future impact of the so-called high-frequency traders, those traders whose ultra-fast computers and sophisticated computer software enables them to buy and sell financial instruments in a fraction of a second, often ahead of pending trades.

While initially blamed for the debacle, the high-frequency traders were quick to complain that they were unduly impugned and expressed relief when Waddell, a mutual fund company based in Kansas, was tagged as being responsible for the trade that triggered the crisis.

However, the recently released report by regulators made it clear that Waddell, which was not mentioned by name, did nothing illegal. Rather, the report stated that there were identified flaws in a computerized trading algorithm that resulted in a failure to sufficiently take into account price and volume factors prior to executing an exceedingly high volume transaction.

Translated, the tremendous size of a sell order in the futures market caused a panic in the equity markets, setting off a chain reaction that evaporated liquidity and forced equity prices to fall an inordinate amount in a matter of minutes.

While May 6 was certainly an anomaly, the Street’s professional traders are quick to take advantage of smaller abnormalities that continually take place during a regular trading day, offering up a defense that they provide needed liquidity to the markets. Yes, they do provide a degree of liquidity.

However, as we also saw on May 6, when really needed many of those so called liquidity providers were quick to disappear until the markets began to recover, at which point they feasted on the resulting carrion. Nonetheless, Wall Street still offers up the greatest potential for accumulating wealth.

So where do you start? One suggestion might be to look at the technology sector in general and Intel (INTC) in particular. I have not discussed Intel for several years because the company has had a miserable performance in terms of stock price appreciation, specifically a negative 24 percent return over the past three years. However, that appears to be changing as Intel casts its net of innovation over an ever widening marketplace.

For its most recent quarter ended June 26, the company reported record third-quarter revenues of $11.1 billion, an increase of 18 percent over the comparable period a year ago. Operating income came in at $4.1 billion, with net income of $3.0 billion and earnings of $0.52 per share.

The company’s gross margin was 66 percent of revenue and was consistent with prior guidance of 65 to 67 percent. The effective tax rate was 30.5 percent, slightly below the company's expectation of approximately 32 percent. More important is Intel’s outlook for the future. According to its most recent guidance, Intel is expecting fourth quarter revenue of $11.4 billion, plus or minus $400 million, with a gross margin number of 67 percent, plus or minus a couple percentage points.

The intrinsic value of the shares using a discounted earnings methodology with an earnings growth rate of 12 percent and a discount rate of 10 percent is $25 per share. The more conservative free cash flow to the firm model generates an intrinsic value of $47 per share.