Three weeks ago, I announced my intention to create a portfolio composed of 10 companies that investors have unjustly cast aside. My goal in creating the One Person's Trash Is Another Person's Treasure portfolio is to highlight just how successful value investing and contrarian viewpoints can be, as well as uncover some great companies that have a good chance of turning their fortunes around. For a more thorough explanation of what I hope to accomplish and how I'll measure my success, I encourage you to visit my portfolio mission statement.
For reference, here are my previous three selections:
For my fourth selection, I've chosen PC maker Dell (DELL.DL), a company I currently own in my personal portfolio.
Why traders have given up on Dell
Traders have given up on Dell, and its other PC cohort Hewlett-Packard (HPQ 0.29%), primarily because they see a shift in PC demand from standard desktops and heavier laptops to mobile tablets and even smartphones.
This year marks the first time since 2001 that total PC sales are expected to fall (albeit by less than 1%). Some of this blame can be placed on consumers waiting for the release of Microsoft's (MSFT 0.18%) new Windows 8 operating system, but a good chunk of the problem was simply the emergence of more mobile device options given the introduction of new Apple (AAPL 0.09%) iPad and iPad Mini, as well as iPhone models, and older-generation mobile device models getting cheaper (such as free Apple iPhone 3GS and even 4 models with plan upgrades).
The entire sector has felt the pinch of declining PC sales, with chip makers Intel (NASDAQ: INTC) and Advanced Micro Devices (AMD 4.95%) reducing their earnings forecasts. AMD has taken things one step further by restructuring its business and announcing layoffs totaling as much as 15% of its workforce. Microsoft's share price has also been under pressure with the assumption that fewer PC sales may impact Windows 8 revenue, although we'll have to wait until Microsoft's next quarterly report to find out the full answer to that conundrum.
In Dell's most recent quarterly results, it noted an 11% decline in sales to $13.7 billion from the year-ago quarter as its adjusted profit slipped to just $0.39, down 28%. This might seem downright awful, but considering that HP wrote off $8.8 billion from its Autonomy acquisition, Dell isn't doing too bad.
Why investors should trust Dell
Just as I did with QLogic, I'm going to sort of retool this section and make it into "Why I bought Dell in the first place!"
The first aspect about Dell that has me excited is its newer series of lighter laptops. With prices on laptops having fallen to attractive levels, and Dell going head-on against Apple's light MacBook Air, I'm excited about Dell's chances of boosting PC-sales in 2013 and moving considerably more PCs this Christmas than even it and analysts have predicted.
Second, it's all about Dell's alternative businesses as well. We often get this boxed judgment that Dell is nothing more than a PC company, when in actuality it also has a cloud-computing and mobile segment as well. Server and networking revenue rose by 11% in Dell's most recent quarter and is slowly becoming a bigger part of its sales pie. With Cisco Systems predicting cloud-computing revenue of $241 billion by 2020, Dell has plenty of room to expand its server line and snag new clients. Let's not forget as well that server and networking business generate recurring revenue which makes earnings visibility easier to forecast.
Finally, the valuation just made sense when I bought Dell three weeks ago. When I purchased the company, it was valued at just a hair over five times forward earnings and had a net of $5.15 billion in cash per share. With the ability to produce in the neighborhood of $3-billion-plus in free cash flow each year, it'd have its weight in cash within three years if it just kept saving! I'll freely admit that its 3.3% dividend yield played a part in my excitement as well.
What you'd get here
If you buy Dell, you're getting a PC company that is in the midst of a transformation. While not giving up on its PC line, Dell is building out its service, mobile, and networking sectors worldwide in order to reduce business cyclicality (since most of this revenue is recurring) and boost its margins.
Currently valued at just six times forward earnings, Dell trades at less than half of the trailing P/E of the S&P 500, despite an expected growth rate of 5.7% over the next five years. While not a company that's going to magically rejuvenate sales overnight, Dell offers investors a very safe yield of 3.3% while they wait -- and it's my feeling that this yield will move even higher, as its current payout ratio is just 19% of the midpoint of projected 2012 EPS. Dell shareholders are well protected by more than $5 billion in net cash and I'd even go so far as to say that its strong cash flow makes the company an attractive takeover candidate at these depressed levels.
Check back next week, when I unveil the fifth in a series of 10 selections for the One Person's Trash Is Another Person's Treasure portfolio.
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