<THE RULE MAKER PORTFOLIO>
Is Dell Making Rules?
Nope.
By Tom Gardner ([email protected])
ALEXANDRIA, VA (Feb. 24, 1999) -- On February 16th, Dell Computer (Nasdaq: DELL) broadcast its fourth-quarter earnings report to the marketplace, and investors treated it with a gasp!
Rumors of a revenue shortfall had been trickling in since February 1st, and the stock had fallen 15%. The rumors proved correct. In less than 24 hours after that shortfall showed up in the earnings announcement, the stock dropped from $93 to $77. All told, Dell, one of the best-performing stocks of the last decade, had fallen 30% from its 1999 high of $110 per share.
The Dell message board in Fooldom was buzzing. Had the company's lead in inventory management been eroded? Was Gateway taking business from the Austin-based giant? Was it time for Compaq to reclaim the PC market for its own?
The subject of Dell and the PC market is actually something we've considered in great detail at the Rule Maker Portfolio site. All the way back in March 1998, just two weeks after our launch, Al Levit was considering Dell as a potential investment (Does Dell Belong Here?).
The question that Al asked back then, I will ask again today. Is Dell Computer --whose stock has risen 110 times its price in 1992, creating numerous Dellionnaires in Austin, TX and plenty more around the country -- making the rules in a profitably expanding industry?
Let's take a look at some of its key numbers for the fourth quarter.
Dell's 4th Quarter
1999 1998
Sales growth 48% --
Gross margins 23% 22%
Net margins 8% 7.7%
Shares out. 1386 m. 1476 m.
Cash $3.2 b. $1.8 b.
L-T Debt $512 m. $17 m.
Cash-to-Debt 6.25x 106x
Flow ratio 0.85 0.77
And now let's punch them into the Rule Maker system, outlined in Rule Breakers, Rule Makers. A few of these rankings are subjective, so I encourage you to run the numbers for yourself, if you're interested in following Dell's business.
1) Brand (0-1pts)
Familiarity 1
Openness 1
Optimism 1
Legitimacy 1
Inevitability 0
Solitariness 0
Humor 1
Subtotal 5
2) Position (0-2 pts)
Mass Habit 1
Gross Margins 0
Net Margins 1
Sales Growth 2
Cash-to-Debt 2
Fool Flow Ratio 2
Your Interest 2
Subtotal 10
3) Direction (0-3pts)
Gross Margins 3
Net Margins 3
Shares Out 3
Cash-to-Debt 0
Fool Flow Ratio 0
Growth Potential 3
Subtotal 12
4) Monopoly (0-4 pts)
Gross Margins 0
Net Margins 2
Cash-to-Debt 0
Fool Flow Ratio 2
Convenience 4
Subtotal 8
5) Your Enjoyment 1
Brand Total: 5 points
Position Total: 10 points
Location Total: 12 points
Monopoly Total: 8 points
Enjoyment: 1 point
Rule Maker Score: 36 points
Unfortunately for Dell, this does mark a decline from its third quarter numbers, at which point its total score was 40 points. Interestingly, the decline is entirely linked to comparisons between Dell and its lead competitor, Compaq. Dell's controlling grasp over the sale of built-to-order personal computers has been loosening of late.
Through perseverance, Compaq has now leapt to the lead in gross margins, nibbled down Dell's lead in net margins, and narrowed the gap on the flow ratio.
These small reversals point to the difficulty of creating a Rule Making company in the PC market. The real challenge in this industry is trying to establish a sustainable brand advantage. If computer buyers can be convinced to think "Dell" and to buy "Dell," instinctively, they'll focus less and less on pricing. In that scenario, Dell can then use its brand loyalty to exert pricing power over its stable of millions of loyal buyers.
You want Dell so much that you pay an additional $300 to own its box.
The problem is that the higher the cost of a product, the more difficult it is to establish brand loyalty. The unwritten rule in the consumer markets is that brand loyalty dissipates the farther and farther you get above a $100 price tag. At $100 per item, Jane Average consumer will wonder if there are competing products. At $500 per item, Jane Average consumer will then explore alternatives. At $1000 per item, Jane Average consumer will more rigorously compare and contrast all relevant products in the category. And at $10,000 per item, Jane Average consumer will sit down in that car dealership and haggle!
The farther a product gets above that $100 price point, the more difficult it is for its provider to establish a brand advantage. Pricing overwhelms brand loyalty. And that's the difficulty of Dell's position. That's why the company -- to my thinking -- does not get to play the role of king in a sensationally good industry. Every new inch of leadership that it claims is eaten back by the ability of competitors to play the PRICING card.
The average computer buyer will look very closely at the alternatives.
Now, this does not mean that I'd sell my Dell stock tomorrow. Certainly not. But it does mean that, barring a unique turn in the business, I wouldn't expect Dell to much outperform its industry from here. More importantly, for Rule Maker investors, I'm not inclined to set a holding period of five-to-ten years. In fact, I'd resist ever doing so -- unless Dell can fight its margins higher, lock-down its brand as the exclusive, and make a monopoly of the machines that get us online.
Great company. But I don't think that's likely.
I'll be back tomorrow to introduce a new Rule Making Fool to you all, and to set the stage on some new services we'll be providing to you in the weeks ahead (including the Rule Maker Spreadsheet!).
Tom Gardner, Fool
02/24/99
Close
Stock Change Bid AXP -3 15/16 107.69 CHV - 7/16 78.31 CSCO -3 99.94 KO + 5/16 62.88 GPS -2 1/2 62.75 EK - 1/2 68.94 XON + 6/53 67.86 GM - 9/16 85.00 INTC -3 7/8 130.38 MSFT -2 9/16 152.88 PFE -1 3/8 132.50 SGP - 1/8 55.19 TROW -1 25/32 30.56 YHOO -2 11/16 150.19 |
Day Month Year History
R-MAKER -1.99% -3.00% 5.18% 33.09%
S&P: -1.40% -2.05% 2.29% 26.59%
NASDAQ: -1.56% -6.64% 6.69% 41.53%
Rule Maker Stocks
Rec'd # Security In At Now Change
2/3/98 24 Microsoft 78.27 152.88 95.32%
5/1/98 55 Gap Inc. 34.37 62.75 82.57%
6/23/98 34 Cisco Syst 58.41 99.94 71.10%
2/3/98 22 Pfizer 82.30 132.50 61.00%
2/13/98 22 Intel 84.67 130.38 53.97%
2/17/99 16 Yahoo Inc. 125.81 150.19 19.37%
8/21/98 44 Schering-P 47.99 55.19 14.99%
5/26/98 18 AmExpress 104.07 107.69 3.48%
2/27/98 27 Coca-Cola 69.11 62.88 -9.02%
2/6/98 56 T. Rowe Pr 33.67 30.56 -9.24%
Foolish Four Stocks
Rec'd # Security In At Value Change
3/12/98 17 General Mo 72.41 85.00 17.39%
3/12/98 20 Eastman Ko 63.15 68.94 9.17%
3/12/98 20 Exxon 64.34 67.86 5.48%
3/12/98 15 Chevron 83.34 78.31 -6.04%
Rule Maker Stocks
Rec'd # Security In At Value Change
2/3/98 24 Microsoft 1878.45 3669.00 $1790.55
5/1/98 55 Gap Inc. 1890.33 3451.25 $1560.92
6/23/98 34 Cisco Syst 1985.95 3397.88 $1411.93
2/3/98 22 Pfizer 1810.58 2915.00 $1104.42
2/13/98 22 Intel 1862.83 2868.25 $1005.42
2/17/99 16 Yahoo Inc. 2013.00 2403.00 $390.00
8/21/98 44 Schering-P 2111.7 2428.25 $316.55
5/26/98 18 AmExpress 1873.20 1938.38 $65.18
2/27/98 27 Coca-Cola 1865.89 1697.63 -$168.27
2/6/98 56 T. Rowe Pr 1885.70 1711.50 -$174.20
Foolish Four Stocks
Rec'd # Security In At Value Change
3/12/98 17 General Mo 1230.89 1445.00 $214.11
3/12/98 20 Eastman Ko 1262.95 1378.75 $115.80
3/12/98 20 Exxon 1286.70 1357.27 $70.57
3/12/98 15 Chevron 1250.14 1174.69 -$75.45
CASH $185.03
TOTAL $32020.86
Note: The Rule Maker Portfolio began with $20,000 on February 2, 1998, and
it adds $2,000 in cash (which is soon invested in stocks) every six months.
