Warren Buffett has famously said that investors should "Be fearful when others are greedy, and greedy when others are fearful." Amid the recent panic in the markets, Buffett's been true to his word, buying U.S. equities for his own portfolio. If you're eager to follow in the Oracle of Omaha's footsteps, you may want to start your watch list with one greenback-heavy business trading at impressively low prices: PC titan Dell (NASDAQ:DELL)
Do I hear a cash register?
Dell is one of the most cash-rich businesses on the planet, thanks to a cash conversion cycle unparalleled in the computer industry. Dell sells PCs directly to consumers and businesses through its website, unlike competitors Hewlett-Packard (NYSE:HPQ), and Sony (NYSE:SNE), which mostly sell through retail stores. By cutting out the proverbial middleman, Dell saves bucketloads of cash.
Nonetheless, the company has struggled in recent years. Michael Dell returned as CEO in 2007, after several years in a mostly hands-off role at the company. But the stock price hasn't been similarly rejuvenated. It's down nearly 50% year to date, and after torrid gains as an up-and-comer, Dell has a trailing-five-year annualized return of around negative 20%.
Nonetheless, what's past is past, and I believe now is a good time to look at Dell for your portfolio. For an analysis of the company's current valuation, check out Inside Value subscriber neglecttheherd's recent post on our premium newsletter service's Dell discussion board (subscription or free trial required):
I believe the current price at which Dell is selling is just absurdly low. In my opinion it might be one of the safest (long-term) stock to own with a very wide margin of safety...
Further it is currently priced at ridiculously low price/sales (last 12 months) multiple of 0.41. Assuming it goes back to just a multiple of 1 it should be valued at almost $33. Historically, it and similar companies like HP (currently at .9 times) has sold for at least a multiple over 1. Assuming there is a slow down and the next 12 months sales are impaired by 25%, it should still be have a P/S of .75 which would give a value of around $25 (still almost a margin of safety of over 55%). Also of note is that 47% of its revenues come from outside the U.S.
Surveying the competition
Although Hewlett-Packard and Apple (NASDAQ:AAPL) have better competed with Dell in recent years, Dell still earns stratospheric returns on invested capital with much lower margins. The company's lean working capital requirements give it a definite edge over competitors.
However, a good business can be a lousy investment if purchased for the wrong price, especially in a commodity business like computers. Dell's margins have been squeezed lately, as neglecttheherd's post goes on to note:
Even though operating margins are under pressure currently, Michael Dell and his team are focused on reducing expenses and improving margins by selling investments. Further it generates healthy free cash flow. Last year it generated FCF of more than $3 billion (excluding acquisition of companies), which it can use to repurchase it shares that are truly undervalued or to acquire companies at discounted valuations.
As neglecttheherd mentioned, Dell produced more than $3 billion in free cash flow last fiscal year, and it should produce a similar amount in 2008. The company already has roughly $7 billion of net cash sitting in its bank account. On an enterprise value-to-free cash flow basis, Dell is selling for about six times free cash flow.
That's dirt cheap.
But there's more!
In Michael Dell's most recent annual letter to shareholders, he set a company goal of achieving $3 billion in annual savings through cost reductions over the next three years. It's not a stretch to say that Dell could be producing as much as $6 billion of annual free cash flow by 2011 -- approximately 25% of Dell's entire current market value!
Plus, Dell is an extremely aggressive repurchaser of its own shares, and it's only become moreso this year as the stock price has fallen. If Dell can somehow bring the share count down to 1.5 billion, and we apply a conservative multiple of 10 to an estimated $6 billion of free cash flow in three to five years, I come up with a future intrinsic value of $40 per share.
A Fool's final thoughts
Dell seems to have a cushion right now, even though bears would claim that the company has permanently lost its competitive advantage. Ben Graham wrote that "the function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future."
With so much cash flow relative to price, today's prices make Dell an attractive stock idea for long-term investors. After all, the Oracle of Omaha hasn't been so publicly bullish about U.S. stocks since the 1970s. If you're looking to get greedy, a cash-rich company with a margin of safety -- like Dell -- is a good place to start.
