Many investors readily identify fear and greed as obstacles to stock-market success. Yet an equally sinister pitfall lurks in everyday investing life: conventional wisdom. Effortlessly insinuating its way into our thought processes, conventional wisdom drives cocktail-party chatter, televised financial news coverage, and stock message-board exchanges. It is both subtle and relentless. We fall victim to its hold by taking confidently expressed statements as matters of fact, or by nodding along in agreement to others repeating popular viewpoints.
Fortunately, as with many self-imposed afflictions, awareness and dispassion are important steps to recovery. And the most effective antidote for counteracting conventional wisdom's influence is due diligence.
Which one do you like?
To illustrate this point, consider Wal-Mart
That may very well be where the similarities end. Wal-Mart's business is much more diversified, targeting consumers' everyday purchases, as opposed to Dell's narrower focus on less-frequent computing and peripheral purchases. In fiscal 2006, Wal-Mart's $312 billion in net sales were nearly six times larger than Dell's $56 billion. In addition, Wal-Mart's market capitalization is nearly four times larger than that of Dell's.
In today's slowing macroeconomic backdrop, Wal-Mart appears to be a safer, more defensive stock than Dell. Unlike Dell, its business is not significantly exposed to corporate IT budgets, a maturing PC market, or technology product cycles. In addition, Wal-Mart's competitive moat appears to be more robust than Dell's. Forged through formidable economies of scale, Wal-Mart's cost leadership position remains intact, whereas Dell's low-cost status appears under assault from reinvigorated competitors like Hewlett-Packard
Given all this, it appears that investors can close the book on Wal-Mart and Dell. Yet, as the following trivia quiz may indicate, the financial truths about both companies might confound your preconceived notions.
1. Which company has experienced higher sales growth since (a) 1990 and (b) the deflation of the tech bubble in 2001?
Surprisingly, Dell is the answer to both. From 1990 to 2006, Dell grew sales from $389 million to nearly $56 billion, representing 36% annualized growth. Over the same time frame, Wal-Mart grew sales from less than $26 billion to $312 billion, for 17% annualized growth. From 2001 to 2006, Dell grew sales 11.9% annually, vs. Wal-Mart's 11.6%.
2. Which company has higher gross margins? Higher operating margins? Higher net margins?
Despite Dell selling higher-priced merchandise, its 18% gross margin trails Wal-Mart's 23%. Yet Dell's lower operating-cost profile allows it to earn higher operating and net margins, at 9% and 6% respectively, versus 6% and 4% for Wal-Mart.
3. Which is the more capitally intensive business?
Wal-Mart spent $14.6 billion in capex in 2006, representing 5% of sales and 83% of operating cash flows. Dell spent $728 million in capex in 2006, representing 1% of sales and 15% of operating cash flows.
4. Which company has reduced its diluted share count more significantly since 2000?
Despite Dell's reputation for egregious options issuance, the company's diluted shares fell 15% since 2000, from 2.73 million to 2.32 billion. Over that time, Wal-Mart's diluted shares fell 7%, from 4.47 million to 4.17 billion. Since 2000, Dell has spent $19.3 billion on net stock repurchases, versus $17.2 billion for Wal-Mart.
5. Which company's net cash balance represents a greater proportion of its market cap?
Partly due to its outstanding cash-conversion cycle, Dell has $10.6 billion of net cash (total cash, marketable securities, and investments, minus debt) on its balance sheet, representing more than 20% of its market cap. Wal-Mart, in contrast, has $32.6 billion of net debt on its balance sheet, representing 17% of its market cap.
6. Which company trades at the less expensive valuation?
The answer varies by the metric used. Both companies trade at 0.7 times enterprise value-to-sales. On a price-to-tangible book value basis, Wal-Mart trades at 4.6 times, versus 14.5 times for Dell, a reflection of Dell's inventory- and property-light business model. According to Quote.com, Wal-Mart trades at a forward P/E ratio of 15.3, versus 19 for Dell, and a trailing P/E ratio of 16.7, versus 14.4 for Dell.
The metric that I most prefer, due to its ability to normalize balance sheet effects, is the ratio of a company's enterprise value (EV) to its trailing-12-month unlevered free cash flows (FCFu: free cash flows adjusted to exclude the after-tax impact of interest income or expense). By this measure, Dell rates far cheaper, trading at 10.9 times, vs. 46.2 times for Wal-Mart. The pronounced difference is due in large part to the heavy capex burden Wal-Mart requires to drive growth.
7. Which company achieves higher cash returns on invested capital (CROIC)?
As earlier answers would suggest, Dell achieves far higher cash returns on invested capital (similar to ROIC, except that unlevered free cash flows replace net income in the numerator). Dell's 2006 CROIC registered at 51%, vs. 4% for Wal-Mart.
8. Which company's stock has seen more pronounced recent insider buying?
Dell's eponymous chairman bought 2.9 million shares at a $24 average price in late May of this year. Wal-Mart's insider buying has been much more muted; two directors purchased 7,800 total shares at prices between $45 and $53 in 2005.
In investing, there should be no substitute for doing your own homework. Chances are that investment opinions derived independently will trump ever-seductive conventional wisdom.
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