When I began investing, I was starting from a knowledge base of zero. Nada. Absolute scratch.
One of the first books I read was The Motley Fool's Rule Breakers, Rule Makers. In it, Motley Fool co-founder and CEO Tom Gardner laid out specific criteria for crowning a company a "Rule Maker," i.e., a large, mature, consumer-facing company that's king of its market space, and an investment that can be confidently and profitably held onto for years with only quarterly check-ins.
His step-by-step process for analyzing a business was an easily understandable way for a beginner like me to quickly get up to speed, but its back-to-basics methodology will benefit even advanced investors.
Today we're going to run semiconductor giant Intel (NAS: INTC) through Tom Gardner's merciless gauntlet and see exactly what it takes to make the Rule Maker grade. In the course of our analysis, we'll use quarterly earnings numbers for the period ending Oct. 1 of this year.
The mass-market, repeated purchase of low-priced goods
In 1965, Intel co-founder Gordon E. Moore proposed the notion that computing power doubles approximately every two years. This theory became known as "Moore's Law" and has accurately predicted the development of the computer ever since.
Since the Intel chip in your computer becomes obsolete essentially every two years, you're compelled to buy a new machine on about the same schedule. You might stretch it a bit, but probably not by much. So computers, and hence the semiconductors that drive them, are perfect examples of mass-market items that grow obsolete fairly quickly and will need to be replaced over and over. Intel easily makes the Rule Maker grade here.
Gross margin indicates pricing power and manufacturing efficiencies. Per Tom Gardner, the ideal gross margin for a Rule Maker is 60%. Intel's easily makes the grade at 63%.
Although having an unquestionably strong foothold in the semiconductor arena, the company does have some competitors -- for example, Advanced Micro Devices (NYS: AMD) . Its gross margin is 48%. We can also consider Texas Instruments (NYS: TXN) as a peer, and its gross margin is a respectable 51%.
Net profit margin
As Tom Gardner so aptly puts it in the book, "The reward of high gross margin is surpassed only by the treasures of high net profit margin." As a reminder, net profit margin tells us how much money a company gets to keep from every dollar of sales. Intel's is a whopping 24%. Well done.
Year-over-year sales growth counts even for big companies, where it will naturally slow with age, because it's an indicator of business momentum. Top-tier Rule Makers grow their sales by 10% every year.
Rule Maker Apple (NAS: AAPL) grew its revenue by a staggering 39%, but Apple is the Superman of tech companies. In a still-virile display of market-dominating position, Intel grew its revenue by an incredible 20% over the past 12 months. Kudos.
Rule Makers should be cash-heavy and debt-light, ideally having at least 1.5 times as much cash as debt. A look at the asset side of the balance sheet shows us Intel has $22 billion in cash, cash equivalents, and short-term investments. On the liabilities side, it has a little more than $2 billion in long-term debt. This gives Intel a cash-to-debt ratio of 11. Bravo.
The Foolish Flow Ratio
The Foolish Flow Ratio measures how well a company manages its inventory and cash. Specifically, a company should be keeping its inventory and accounts receivables low and its accounts payables high -- strong indicators of market-space dominance.
To calculate the Foolish Flow Ratio, take current assets minus cash, cash equivalents, and short-term investments and divide by current liabilities. The best companies have Foolish flow ratios of 1.0 or less; 1.25 is acceptable as the upper end. Intel's is exactly 1.0. Nicely done.
Your familiarity and interest
What's in a name, you ask? A lot. Your familiarity and interest help you understand exactly what a company does and how it makes money, thereby lowering your investing risk.
For a company that makes the internal part of a machine that, I'd wager, very few people outside the tech industry have ever actually seen, Intel has been remarkably savvy in getting its name known to the general public. Brand recognition isn't up there with fellow Rule Maker Starbucks (NAS: SBUX) , and it certainly isn't equivalent to Rule Maker Coca-Cola (NYS: KO) , but it might be equal to Procter & Gamble (NYS: PG) , another Rule Maker.
Moore's Law makes for a Foolish investor's dream
Beautiful top and bottom lines. Loads of cash and very little debt. A killer gross margin. Strong brand recognition in a mass-market, repeat business. An enviable Foolish Flow Ratio. Intel is a Rule Maker of the highest order. There's nothing not to like at the moment, but remember that the metrics used here should be applied to all of your Rule Maker investments each quarter.
In Rule Breakers, Rule Makers, Tom Gardner goes into even greater depth and detail about what exactly makes a Rule Maker a Rule Maker. So I suggest you pick up a copy for yourself and get the whole story from the man who literally wrote the book on it.
Intel isn't the only stock you can profitably and confidently hold onto for the long term. My fellow Fools have picked out -- and bought shares of -- five more companies they think will maintain their edge and outperform over the long term. You can get a free copy of their special report.
At the time thisarticle was published Fool contributorJohn Grgurichruns his computers until they're begging to be replaced, and he owns no shares of any of the companies listed in this column. The Motley Fool owns shares of Intel, Apple, Coca-Cola, and Starbucks and has bought calls on Intel.Motley Fool newsletter serviceshave recommended buying shares of Apple, Intel, Coca-Cola, Starbucks, and Procter & Gamble and creating bull call spread positions in Apple and Intel. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.
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