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February 26, 1999 Dell Computer has been in the news lately, and even leading the NASDAQ in volume, because of its recent quarterly earnings report. On Feb. 16th, Dell reported quarterly earnings up 55 percent over a year ago, with revenue up 38 percent to $5.2 billion for the quarter. (They also announced a 2 for 1 stock split, effective next week - all the numbers in this article are pre-split.) These look like great numbers, but the revenue growth was the lowest in five quarters. The stock got hammered on the news, dropping 8 percent in a day. Since the all-time high of $110 on Feb. 2nd, the stock has dropped to today's close of 80 1/8. Merrill Lynch lowered their estimates for Compaq today, and this hit Dell and the other PC makers too. So the big question is: Does this drop represent a buying opportunity, or does it mean that things are changing for the worse at Dell? Another way to look at this is to ask: Is Dell underpriced or overpriced at $80 a share? The fundamentals look bad on first glance - a P/E of 78, price to book of 53 - this stock is sky high. But look a little deeper: the book value of Dell is $1.53 and earnings on an annual basis are $1.05. In other words, Dell earns back 67% of the money invested in the business in just one year! Dell doesn't pay a dividend, so these retained earnings are compounding. Here's what the compounding looks like for five years:
If we assume a more modest PE of 50 five years hence, this works out to a price of $716 a share. Not too shabby! Michael Dell has built a remarkable company. Their devotion to the direct sales model cuts out the middleman. Their devotion to just in time manufacturing keeps inventory costs low and lets them exploit dropping parts prices. Dell computers have an excellent reputation for quality and value that only grows by word of mouth, and with each new favorable magazine review. Dell's rival Gateway has not been quite as nimble, and Compaq is expanding into other areas of computers, leaving Dell as the leading PC company. The PC industry is still quite fragmented and we can expect it to consolidate, and in a consolidating industry, it's good to be the leader. In other words, I say Dell is a buy and this drop is a buying opportunity. Today's close: Dow 9306, S&P500 1238, NASDAQ 2288 January high: Dow 9643, S&P500 1279, NASDAQ 2510 September low: Dow 7539, S&P500 956, NASDAQ 1419 The market has pretty much gone sideways this month. But look how far we've come - the NASDAQ was just 1419 half a year ago.
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