You may have heard that some of the biggest tech giants plan to build enormous data centers to power artificial intelligence (AI) and many other functions, but the scale may surprise you.
Companies like Amazon, Alphabet, Microsoft, and xAI (founded by Elon Musk) require centers that can exceed 1 million square feet. The centers house thousands of servers, racks, and other infrastructure, and the demand will likely increase. As shown below, the construction of massive data centers is accelerating.
Importantly, Dell (DELL -2.06%) doesn't just make computers; it also supplies critical infrastructure to this industry.
Image source: Statista.
Momentum in key segments
Dell is a key partner when the "hyperscalers" mentioned above construct data centers. Along with Super Micro Computer, Dell is a vendor for xAI's ambitious project to build the largest supercomputer in the world. The site will reportedly contain 100,000 Nvidia GPUs and occupy more than 750,000 square feet. With Super Micro struggling at the moment and delaying its annual 10-K filing, Dell could see an even greater share of the work.
Dell's latest results (for the second quarter of fiscal 2025, ended Aug. 2) saw $3.2 billion in revenue for AI-optimized servers, up 23% from the prior quarter. Traditional server sales also increased for the fifth straight quarter as its infrastructure solutions group (ISG) segment hit $11.6 billion on 38% year-over-year growth. This segment powered an overall revenue increase of 9% to $25 billion despite a challenging market for consumer PCs.
The ISG segment still has a long runway. Dell predicts its addressable market will increase from $79 billion in 2023 to $174 billion in 2027, which is excellent news for investors.
More positives for investors
Positive free cash flow is the lifeblood of businesses and one of the critical factors I look for in a company. It allows the company to fund growth, pay dividends and buy back stock, and fund operations without being saddled with too much debt. Dell reported free cash flow of $1.3 billion last quarter and $6.1 billion in the previous 12 months.
Dell increased its dividend by 20% this year to $1.78, resulting in a 1.5% yield. The yield is nothing to write home about; however, the company plans to increase the dividend by 10% yearly through fiscal 2028. Plus, you don't usually buy tech companies for income. Think of it more like a bonus.
Dell also buys back a lot of stock -- $3 billion over the last 12 months, nearly 4% of the current market capitalization. With the company planning to return 80% of its free cash flow to investors, the pace of buybacks will likely continue, further lowering the share count and increasing value for investors.
Is Dell overvalued?
This is a great question. As you can see below, the company's price-to-earnings ratio is higher than its recent average, even after the recent decline; however, it drops below this on a forward basis.
DELL PE Ratio data by YCharts
In addition, forward ratios are based on analyst estimates. I believe Dell can beat these estimates due to the intense demand and challenges that Super Micro faces. There are no guarantees in investing, only a calculation of risks and rewards. Still, I see a pathway to market-beating gains for Dell investors through the next fiscal year and beyond.
