Dell Is Dead to Me

This is what newshounds might refer to as a "two-fer."

First of all, it's big news, right? Dell (NASDAQ:DELL) lowers guidance. That'll guarantee everyone reads our story, right? Big news. Next, they get to claim that Dell is bringing down all of "tech" or maybe even the entire Nasdaq -- should the newshounds get their day of red.

We'll get to point one in a second. Point two, I am compelled to note, is absolute garbage. Dell's dropped guidance has nothing to do with, say, Apple's (NASDAQ:AAPL) downswing today, nor with currently-in-the-red Cisco (NASDAQ:CSCO), Intel (NASDAQ:INTC) or AMD (NYSE:AMD).

Nope, Dell's problems are just Dell's. And on the surface, they don't look nearly as bad as all those headlines would have us believe. In fact, they're so brief that I'm just going to quote the opening paragraph in full.

Dell said today it expects to achieve GAAP earnings per share of approximately 33 cents for its fiscal 2007 first quarter and expects revenue of approximately $14.2 billion versus its original guidance of $14.2 to $14.6 billion and earnings per share of 36 to 38 cents, including an estimated three cents of stock-based compensation. The shortfall in earnings versus previous guidance was driven primarily by pricing decisions in the second half of the quarter that the company expects will accelerate revenue growth in the future.

Let's take a look at what that means. It'll be an 11% drop in quarterly earnings from last year, and, coincidentally, an 11% drop from the midrange of the previous guidance.

Does that warrant today's 4% haircut, taking the shares to roughly the same level they occupied five years ago? Perhaps. That might sound funny coming from a value-type, but as cheap as Dell has become, it's not cheap enough for me.

The problem with Dell isn't cash flow -- it's got plenty of that. The problem is keeping that cash flow on the grow.

I'm not so sure Dell can pull that off. As my colleague in cheapness, Chuck Saletta, recently pointed out, Dell isn't really the low-cost provider. Dell is a brand name -- and one that manages to alienate a fair number of customers, in my family at least. Don't get me wrong; I haven't had much better luck with computers from Hewlett-Packard (NYSE:HPQ) or IBM (NYSE:IBM). But the fact that I can get a machine from any of these providers -- well, not IBM anymore -- or get a fabbo laptop from some company I'd never heard of before called Averatec, well, that fact ought to tell you what this market is like. Wide open.

If that doesn't adequately illustrate the scope of Dell's challenge, maybe this table of margin erosion will.

I think this goes a long way toward explaining why, by my cash-flow valuation models, Dell is currently priced for zero or negative growth for a long time. I'm not sure I believe that end thesis -- it is possible to make up for margin pressure with increased sales. Unfortunately, my numbers show that Dell's free cash flow has grown at a compound annual rate of only 2% over the past half decade, while revenues have struggled to beat a 12% compound growth rate.

Therefore, there's not much reason for me to bet my hard-earned bucks that Dell can turn things around, especially at these prices. With nearly a year before the next big PC operating system upgrade sets off a hardware-selling cycle, I'm not sure I want to put any chips on Dell. It just may get cheaper yet. Talk to me at $19.

Dell is a recommendation of Motley Fool Stock Advisor and Motley Fool Inside Value . You can take a free test drive of either (or both) by clicking here.

Seth Jayson has owned a lot of computers, but at the time of publication, he had no positions in any company mentioned here. View his stock holdings and Fool profile here. Fool rules are here.