Wednesday, March 16, 2011

Is Dell a Bargain?

Here is a GuruFocus interview with Mason Hawkins and Stanley Cates of Longleaf Partners. In the interview, Cates made the case that for Dell (DELL) as an investment.

Cates says the company sells for less than 5 times earnings. He basically thinks Dell is cheap because of a gap between what they actually do and what the perception of what they do is.

GuruFocus: Interview With Mason Hawkins And Staley Cates Of Longleaf Funds

If Dell were still just commodity desktops and notebooks this would be a different story. I am not a huge fan of the business (an industry with too much change and competition from very strong well-financed players) as a long-term investment but the valuation disconnect (at least relative to some high-flyers) seems extreme.

At current prices, Dell's business could shrink in the coming years and still produce a good return. Still, for lots of reasons, a large margin of safety makes sense.

Other value-oriented investors who owned shares in Dell at the end of 2010 include: Joel Greenblatt, Brian Rogers, Jean-marie Eveillard, Richard Pzena, Donald Yacktman, Prem Watsa, John Rogers, Arnold Schneider, Bill Nygren, and Arnold Van De Berg (though not all were adding to shares in the most recent reported quarter).

It may not make for a great "story" ( and Dell has real difficulties ahead) like some of the current high-flying stocks, but at some point valuation creates a margin of safety that's hard to ignore.

Dell has an enterprise value (market cap - net cash) that's a bit over $ 19 billion. Now, speaking of high-flyers, let's compare Dell to Salesforce.com (CRM).

It has an enterprise value a bit under $ 18 billion.

Not the same as Dell...but close.

Dell's enterprise value to forward earnings*  is ~ 5.8x ($ 19 billion divided by earnings of ~ $ 3.3 billion). This is slightly more conservative calculation than the Cates multiple from above as it does not include finance receivables.

Salesforce.com has an enterprise value to forward earnings* of  ~92x ($ 18 billion divided by earnings of ~$ 193 million).

In the late 90s, Dell was once valued at over $ 125 billion with just over $ 1.4 billion/year in earnings. So a multiple that kind of looks like Salesforce.com now.

Dell may not be capable of earning $ 3 billion plus over the long haul. The transition away from personal computers as their core business makes this difficult to predict. So it is far from an attractive business these days.

Still, investors sometimes seem willing to pay a hefty price for the hope and promise of someday earning lots more money and a whole lot less for a company that actually earns more money.

The promise of growth is worth more than growth already achieved. That's how a company like Dell can lose more than 75% of its market value over a decade plus even though the company now earns more than twice as much money.

No matter how good the story is at the time, it's tough to avoid permanent losses of capital when extreme multiples of earnings are paid.

The fact is there's just no technology business that I'm comfortable with as a long-term investment. Occasionally, some have sold at enough of a discount to be worth the trouble, but they will always remain very small positions. Most are involved in exciting, dynamic, and highly competitive industries.

That's precisely what makes them unattractive long-term investments.

No matter how good business looks today (or how high the expectations are), it's just not that easy to predict their economic prospects many years from now.

With the best businesses that's not the case.

Adam

Small long position in Dell established at lower prices

* Fiscal Year ending January 2012
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