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Intel’s Earnings Torpedo

Intel’s Earnings Torpedo. Objectives of Intel Case. Illustrate the role of sales growth rates and gross margins as the two key drivers of value. Illustrate how the extrapolation of unusually high sales growth rates can have a huge impact on estimates of firm value.

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Intel’s Earnings Torpedo

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  1. Intel’s Earnings Torpedo

  2. Objectives of Intel Case • Illustrate the role of sales growth rates and gross margins as the two key drivers of value. • Illustrate how the extrapolation of unusually high sales growth rates can have a huge impact on estimates of firm value. • Make the point that investors and analysts frequently naively extrapolate high short-term sales growth rates, leading to the ‘earnings torpedo’, whereby stock price takes a sharp drop when these growth rates slow.

  3. Sales Growth At Intel • ‘99 sales growth = 11.9% • 1Q ‘00 YoY sales growth = 12.9% • 2Q ‘00 YoY sales growth = 23.0% • Original forecast of 3Q ‘00 YoY sales growth = 20-27% • Revised forecast of 3Q ‘00 YoY sales growth = 17-19%

  4. Gross Margins At Intel • 1999 gross margin = 59.7% • 1Q ‘00 gross margin = 63.0% • 2Q ‘00 gross margin = 62.9% • Original forecast of 3Q ‘00 gross margin = 63-64% • Revised forecast of 3Q00 gross margin = 62%

  5. Question 2. Suggested Model Assumptions • Sales grow at 28.3% in 2000 and trend down to 5% over the next 20 years • Gross margin is 64% in 2000 and trends back down to 1999 levels over next 20 years • Other costs and expenses constant at eVal defaults • Turnover and financing assumptions constant at eVal defaults • Cost of equity = 12%; Valuation date = 9/22/00 • Price = $61.67

  6. Question 3. Suggested Model Assumptions • Sales grow at 24.8% in 2000 and trend down to 5% over the next 20 years • Gross margin is 62% in 2000 and trends back down to 1999 levels over next 20 years • Other costs and expenses constant at eVal defaults • Turnover and financing assumptions constant at eVal defaults • Cost of equity = 12%; Valuation date = 9/22/00 • Price = $47.73

  7. Why Was the Stock Price Drop So Large? • Recompute the valuation models in questions 2 and 3, but in each case assume that sales growth and margins immediately fall back from the 2000 levels to to 1999 levels in 2001 • Model 4 = $23.94 • Model 5 = $23.35 (a 2.5% drop) • When we extrapolate unusually high sales growth far into the future, small revisions in sales growth can have a huge impact on value • Remember that sales growth is rapidly mean reverting

  8. What Happened at Intel?

  9. Earnings Surprise Response Functions for High and Low Growth Stocks

  10. Key Takeaways From Intel Case • Sales growth rates and gross margins are usually the most critical forecasting assumptions. • When we extrapolate short-term sales growth and/or gross margins far into the future, small changes in these variables can cause large changes in firm value. • Unusually high levels of growth and return on equity are extremely difficult to sustain, but investors often don’t seem to appreciate this fact.

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