What an amazing stock. Simply amazing. Coming off a low of $11 5/16 in the last 52 weeks and resting at $85 as of Friday's open, Dell has risen some 651% -- in just one year! After the celebrations are over and the high-fives have been dealt, one has to wonder if it isn't time to kiss Dell goodbye. For as terrific as the company may be, the stock valuation is another thing.
Trading at about 36 times 1997 consensus forward earnings estimates of $2.32 per share and around 50 times trailing earnings, Dell enjoys a P/E multiple almost twice that of competitors Compaq (28x) and Gateway 2000 (25x). When evaluating a company's prospects, you have to imagine what could happen given any scenario. So let's look at two possible scenarios for Dell, and how the various circumstances might affect its market value.
Scenario 1 -- Things go wrong.Dell hits a few rocks in the road. Perhaps we see some major league price wars in the computer industry, cutting Dell's net margin of 7.5% back to its 5-year average of 4.6%. Perhaps business simply slows down. We are in an unparalleled time of economic expansion that has corporations across the country (and the world) simply giddy with their technology budgets. Dell has been a major beneficiary of this trend. However, should these companies get a whiff of slowing business trends, the first thing to go from the technology budgets will be brand new machines. Businesses will upgrade the old ones with more RAM and better peripherals, but new box purchases will feel a heavier brunt.
Will all of this happen? I don't know. What I do know is that Hewlett-Packard, Compaq, Micron Electronics, and Digital Equipment have all been cutting prices on higher-end machines in an effort to protect market share. Like anything else, it's a question of risk and reward. At $85 a share, should anything actually go wrong with Dell, look out below.
On the other hand, what happens if everything goes right?
Scenario 2 -- Everything goes right. One mistake investors often make in evaluating a company is not paying attention even if everything should go the way they want it to go. So, I find it helpful to assume that the company will fire on all cylinders and still ask myself the question: Is Dell a compelling investment?
Dell has grown earnings and revenue at a 50% annual clip for the past five years, a period that most any sane person would acknowledge has been an incredible time for the growth of personal computers, the Internet, and technology "awareness" in the public eye. Even Microsoft, a company that many consider to be the greatest company of our time, has only grown revenue and earnings at about a 30% annual clip over the past three years. Given this, and given that enjoying 50% growth for a decade is unheard of, I think it's fair to assume that growth will slow "somewhat." Let's assume that Dell grows its earnings at a 30% clip for the next 5 years and then trades at a 30 P/E multiple. With trailing earnings of $3.44 per share and growing at 30% a year, Dell would have $6.39 in trailing earnings in 5 years. At a 30 multiple, Dell would be valued at around $192.
Before you say "WOW!" and buy more Dell shares, consider this: even if it does go to $192 in 5 years, that amounts to 17% annualized growth. 17%, even if things go well (given my assumptions of somewhat slowing growth). The Foolish Four Dow Dividend approach to investing has offered annualized returns of better than 20% on average. So, it seems to me that 17% in one company, if all things go well, isn't a bargain relative to owning the Foolish Four.
Sure, the traders, institutions, and momentum folks might take Dell higher and higher, but the higher it gets, the worse that risk-reward relationship becomes for you as an investor. One thing I know for sure is this: Dell is certainly not the value it was a year ago when Randy Befumo was ringing bells and blowing sirens about it. So, is it time to sell Dell? I think so, yes.
--David Forrest ([email protected])