Thursday, April 17, 1997

Dell Computer Corp.
(Nasdaq: DELL)
Phone: 512-338-4400
Website: http://www.dell.com
Price (4/17/97): $77

HOW DID IT DOUBLE?

The Dell story is a simple one. It has been kicking some butt on the earnings front. The company has handily beat earnings estimates for the past 3 quarters. In the third quarter Dell smashed estimates by 34%, and in the most recent quarter, earnings were 21% ahead of consensus expectations.

The company is a pacesetter in the PC industry in all aspects of financial performance. Return on invested capital was 154% in the fourth quarter, which is an industry record. Earnings have grown sequentially in the past 12 quarters. In year-over-year comparisons, earnings growth has been phenomenal. Over the past four quarters, the company has recorded earnings growth of 50%, 73%, 105% and 189% respectively.

Sales have increased at over 2 times the industry average over the past four quarters. In the most recent quarter, sales grew 57%. In addition, the company has repurchased 11% of outstanding shares over the past year. The company's cash position has increased and operating expenses have declined.

Take your pick. Just about any of these positives could move a stock. Put them all together and you have a Double!!

BUSINESS DESCRIPTION

Dell is one of the top PC makers and is the #1 mail-order PC seller. The company makes and sells a wide range of products, including desktop and notebook PCs, workstations, and servers. It also sells software and third party products through its mail order business.

The company is international in scope with sales increasing steadily in Europe, the U.K., and the Far East. The company also sells computers over the Internet, where sales are clipping along at a $1 million per day pace.

The Dell business model allows it to keep inventories low with computers essentially being made to order. In contrast to competing PC direct marketer GATEWAY 2000 (Nasdaq: GATE), Dell has targeted large businesses and the government for the bulk of its sales. The advantage of direct marketing is that, by cutting out the middleman, Dell can sell its computers at a significant discount. This discount can be as much as 30%, which is very enticing to large customers.

CEO Michael Dell is regarded as a visionary, and under his leadership the company's financial performance is unparalleled.

FINANCIAL FACTS

      Income Statement
      12-month sales: $7759 million
      12-month income: $518 million
      12-month EPS: $2.70
      Profit Margin: 6.7%
      Market Cap: $15176 million

      Balance Sheet
      Cash: $115 million
      Current Assets: $2447 million
      Current Liabilities: $1658 million
      Long-term Debt: $18 million

      Ratios
      Price-to-earnings: 28.5
      Price-to-sales: 1.9

HOW COULD YOU HAVE FOUND THIS DOUBLE?

It should have been easy to find this one. The performance of Dell could have been anticipated on several fronts. First of all, use the Motley Fool Search feature and type in "Dell." You will find a series of articles in the Evening News last fall that point to Dell's potential for price appreciation. Additionally, even with exploding earnings growth, the stock only traded at a PE multiple in the high teens last fall. The disparity between earnings growth and the PE ratio could have alerted investors to a buying opportunity.

In a study by Claudia Mott and Daniel Coker of Prudential Securities published in the book Small Cap Stocks (Klein and Lederman, ed.), it is amply demonstrated that stocks with positive earnings surprises outperform the market as a whole. This effect is amplified with repeated positive surprises. The fact that Dell was smashing estimates put it in a group of stocks likely to outperform

The bottom line -- there was plenty of opportunity to get on the Dell train before it left the station.

WHERE TO FROM HERE?

Looking at the valuation of Dell, it can still be said that the company gets no respect! The PEG comes in at 0.75, meaning that if the company traded at a PEG of 1.0 (something it rarely does), it would deserve a price around $100 a share. Similarly, a YPEG valuation based on estimates of $5.13 for FY 1998 and growth estimates of 25% puts fair value at $128 per share. What is the deal here? You have the fastest growing computer company in the U.S. that is blowing out earnings estimates, buying back shares, improving margins, and in every category of financial performance exceeding expectations. Yet the shares trade at a substantial discount to its growth rate.

The problem for Dell is the perception that it is a commodity business and the fear that in an economic downturn or in a situation where component prices rise, Dell's profits are vulnerable. This fear gives investors a continued opportunity to pick up Dell shares at a discount with some built in downside protection. For an investor looking for a company that generates a lot of cash, has a well-conceived and well-executed business plan, and is selling at a discount to expectations (which have been regularly exceeded), Dell is worth a close look.

-Mark Weaver, MD (MWEAV@aol.com)

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