Investing in PC Component Makers: A Builder's Perspective

While hobbyists building their own PCs are a small segment of the market, they're making the exact same decisions Lenovo or any other major manufacturer is making on cost and performance. Researching a custom build is very relevant to the future prospects of component companies.

The processor
For a desktop computer, there are essentially two processor options: Advanced Micro Devices and Intel . Intel is, by far, the market leader, but AMD remains relevant, and after some hard times seems poised for a turnaround.

Intel's desktop offerings center around high-end i7 CPUs, and cheaper products are scaled-down versions of the i7 with features removed. AMD, by contrast, offers many different underlying designs in the low and mid-price range, all designed to maximize performance at those cost levels. This diversity led to the use of AMD processors in both the Sony PlayStation 4 and the Microsoft Xbox One. This is a significant source of revenue growth for the company going forward, not to mention a vote of confidence from some big hardware makers.

Intel, by contrast, has high-end offerings that AMD simply can't match, and can command a premium price on components that have no peers. Intel's technology also means its mobile processors, designed to use less power and give off less heat, are far ahead of AMD's.

Intel is the safe investment choice here, as the company is consistently profitable and pays a solid 3.8% dividend. If AMD can continue releasing good mid-level products and return to profitability, there is even more upside. However, that upside comes with risk, as AMD's ratios are weaker, and the nature of its business means margins will never match Intel's.

Aside from CPUs, the biggest cost component in a PC is the graphics card. Again, NVIDIA and ATI, a subsidiary of AMD, control virtually the entire market, regularly leapfrogging each other on performance.

Currently, the advantage here goes to ATI/AMD because, as integrated graphics improve, fewer people need a separate graphics card, and AMD's integrated graphics are the best performers out there. Intel also offers integrated graphics on CPUs, and while not quite up to the performance level of AMD's, they're still quite nice. This indicates that the graphics card segment will likely struggle for growth.

While NVIDIA has low debt and a lot of cash on hand, its also priced to assume significant growth, which it may not actually be able to deliver. What the company needs is a game or other substantial app that requires a high-end graphics card and can drive sales.

After years of virtual commodity status, the invention of solid state drives has returned storage to relevance. They offer a big performance boost, but at a high price, which means the low end remains exclusively hard disk drives.

With SSDs too expensive, and HDDs too slow, the big winner in storage is the hybrid drive, which attempts to merge HDDs with smaller, on-board SSDs. They'll never match the performance of SSDs, but they're close, and prices are closer to HDDs. Seagate and Samsung make some of the best hybrid drives, and this should benefit both in the near term.

Seagate is already trading near its 52-week high, so it's not cheap. Still, the company is trading at less than 10 times next year's earnings and pays a nice dividend, so it remains a reasonable value play.

Linux operating systems and other open-source software is improving by leaps and bounds, and is going to be a constant drag on margins. While it's unlikely Linux will take substantial market share from Microsoft, it is an increasingly relevant choice. In the era of Google Chromebooks and Android devices, Windows is no longer the expectation everywhere.

PC makers are likely to continue shipping Windows with their systems, but low-cost alternatives create constant pressure to reduce prices. Microsoft is going to struggle with sustaining its margins, and its future growth depends on hardware and online services segments. It's overpriced. 

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Fool contributor Jason Ditz has no position in any stocks mentioned. The Motley Fool recommends Intel and Nvidia. The Motley Fool owns shares of Intel and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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