A Blue Chip Priced for 20% Annual Returns

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Dell (Nasdaq: DELL  )

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Member Rating:


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Stock Price At Recommendation:


GameStop Profile

CAPS Rating (out of 5)



Round Rock, Texas


Personal computers

Market Cap

$24.7 billion


$12.4 billion / $5.3 billion


Oracle (Nasdaq: ORCL  )

Sources: Capital IQ (a division of Standard & Poor's), Yahoo! Finance, and Motley Fool CAPS.

This week's pitch:
What if I told you that a major blue chip company is priced to deliver 20% annual returns? Would you be interested? If not (really?), then you are just like the 'investors' who sold Dell following its spectacular Q1 report. Apparently a 20% annual return isn't good enough for a company that delivered 21% total top-line growth and 47% revenue growth in the high-margin servers and networking areas. Oh, and of course earnings growth of nearly 18% doesn't mean anything either.

Dell has plummeted by 25% since its wonderful report on May 19th (with friends like these, who needs enemies?). You would think from the market's reaction that the company is on life support, but this is not the case. During the worst of times in 2009, Dell generated $3.5 billion in free cash flow, and investors can buy the company for roughly $17.35 billion once you take into account the company's large net cash position. That translates into a 20% real annual return on your investment, assuming the company has NO growth above inflation. Ben Graham, meet your margin-of-safety.

The real beauty of it is that most of what Dell shareholders can take home or reinvest - its free cash flow - is not even taxed! Thanks to a brutally efficient cash conversion cycle (Dell cycles through its inventory about once a week) the company generates gobs of free cash flow in excess of its reported earnings. In 2009 the company was only taxed on about $2 billion in pre-taxed net income, about half of the $4 billion in pre-tax free cash flow in generated for shareholders. At the end of the day, Uncle Sam only took $591 million and shareholders ran off with about $3.5 billion.

You may want to ask, "but cbaines2, isn't Dell a terrible company with no competitive advantage?" Do you consider Apple [ (Nasdaq: AAPL  ) ] or Google [ (Nasdaq: GOOG  ) ] to be terrible companies? I ask this because Dell’s return on capital is consistently above or at the level of Apple or Google. Yet, Dell trades for only a fraction of their valuation. But don't just take my word for it: the value hounds at Longleaf Partners own about 7% of the company.

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The Motley Fool is investors writing for investors. Dan Dzombak did not have a position in any of the companies mentioned in this article. Pitches must be compelling, made in the past 30 days, and be at least 400 words. Google is a Motley Fool Inside Value selection. Google is a Motley Fool Rule Breakers recommendation. Apple is a Motley Fool Stock Advisor pick. The Fool owns shares of Apple, Google, and Oracle. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.

Read/Post Comments (3) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 29, 2010, at 12:29 PM, jrmart wrote:

    Trying to compare DELL to Apple is like comparing an orange to an apple.

    The tablet market is a new emerging market that Apple could potentially come to dominate in the same way that they dominate the MP3 player market. The new Apple IPAD is quickly replacing PCs in the corporate world and Apple is just starting to penetrate that market.

    Tim Cook, Apple's chief operating officer, noted on a July conference call with analysts that 50% of Fortune 100 companies are already deploying or thinking about using the iPad. That spells big trouble for all the PC makers.

    Apple now defines the whole consumer electronic market place with REAL COOL products like the IPHONE4, the IPAD, the now the new IPODs and APPLE TV. These products set the trend, and some even become fashion accessories. Just check out all the ladies wearing a different colored IPOD nanos each day to match their outfits. WHO SAID WE ARE IN A BAD ECONOMY. A quick visit to the Apple store might change that outlook.

    If you are strictly talking about Apple as a short term trade, then it might be tired after a quick run from $240 to $292. However, its extremely cheap relative to any other large cap growth stock. Apple should earn about $18 per share next year. Its growth rate and consistent stream of surprises should lead to a PE of 20. That gets Apple to $360. Now add $45 in cash per share and you get $405. Lots of people are willing to pay a PE of 40 for Amazon. If you do the same for Apple then Apple would trade in the seven hundreds. Right now Apple is underpriced.

  • Report this Comment On September 29, 2010, at 1:29 PM, TheDumbMoney wrote:

    I'm a fan of Apple and have in the past always regretted not buying. I take issue with this though: "The new Apple IPAD is quickly replacing PCs in the corporate world...." No it's not. THe data does not support that. Just because an Apple exec says companies are thinking of deploying the iPad, that does not mean it will replace PCs. It will never replace PCs; that is because it does little that a laptop can't do, and the mobility aspects of laptops have themselves not led to replacement of the corporate PC. And iPad (or other tablets) will only fully replace laptops when Apple: 1) incorporates a sturdy, flip-down stand so you can stand it up like a laptop screen on a desk in a meeting if you want to; and 2) when the tablet can project a totally functional digital keyboard on any flat surface in front of it, in any type of light, so you can still utilize the full screen while typing, and so you can type virtually anywhere you want to type. When and if Apple or any other tablet maker does THOSE things, the laptop (not the PC) is probably toast. Until then, tablets are expensive, luxury peripheral devices for most people, and for most companies. I should add, however, that I don't know what I'm talking about, and that this is just my sense of things.

  • Report this Comment On September 29, 2010, at 3:38 PM, jrmart wrote:

    Dumberthanafool, why do you say PCs and Laptops are not going to be replaced by the Apple IPAD when the University of California at Irvine Medical School just put their 4 year training program on the IPAD. The same is occurring in many Fortune 500 companies. They are using the IPAD as a great sales tool. The IPad connects directly to enterprise mail servers like Microsoft Exchange and Lotus Domino via Exchange ActiveSync providing users push email, calendar events, and contacts. IT can enforce complex passcodes and remotely wipe a lost or stolen IPad instantly. Certificate-based authentication means only approved users get access to Exchange, and encrypted SSL communication to and from the server keeps data safe. IPad also supports standards-based servers for email, calendars and contacts. IMAP servers enable users to sync email and notes. CalDAV support for calendar servers like iCal Server, Oracle Beehive, or Zimbra delivers new events and allows user to create invitations on the go. And LDAP support gives users access to their corporate directories. iPad easily connects with corporate VPN servers to give users secure access to critical business information. The built-in VPN client supports Cisco IPSec, L2TP/IPSec and PPTP tunneling protocols. And VPN On Demand on iPad leverages certificate-based authentication to make connecting to VPN servers transparent to users. Listen, I can understand that lots of people can't afford to buy Apple stock at $290 a share. If you really want an inexpensive play on Apple, buy LQMT.PK for .84 a share. In an 8-K filed on August 9, 2010, it was disclosed that Apple (AAPL) secured specific intellectual property rights from Liquidmetal Technologies ( in exchange for a licence fee. This gives Apple exclusive rights to commercialize the product in the field of consumer electronics, while Liquidmetal will retain the right to market it in all other fields. The product is Liquidmetal, and it could help make an extremely sleek and aesthetically pleasing IPhone or new smaller IPAD that is virtually non-distructable. Liquidmetall is currently being used in a variety of applications, including medical devices, tooling, Department of Defense (that is probably the reason Apple negotiated lifetime licensing rights instead of buying this small company..too much paperwork and restrictions from big brother) and in high-end watches and sporting goods. When Apple reports next quarter, we will find out just how much they paid for this license. Internet postings are saying that Apple paid off all of Liquidmetals Technologies debt. All I know is that the stock shot up from .12 in July to $1.70 when Apple announced the license agreement in August. Since then the stock has settled back between .55 to .89 a share yesterday. If you look at the long term stock chart on LiquidMetals Technologies, you see that it came out several years ago at around $20 a share and then it steadily came down. Now the chart is looking very positive since the Apple license agreement. Buyer/Seller beware, this is a penny stock.

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