Mohan, briefing.com had a comparison between DELL and Compaq in their Stock Brief this morning. Unfortunately, I couldn't reproduce the graphs that were included in the analysis. The story follows below;
Dell Versus Compaq
Dell's earnings report on Tuesday was simply outstanding.
The primary credit goes to the management team for an excellent job of running the company. When you look at the numbers delivered by this team over the past years, it is hard to find anything to criticize.
To show just how well a job Dell has done over the past years, we made a comparison of Dell and Compaq, the company most similar to Dell in size and direction. There are, of course, differences in strategy between Dell and Compaq, but those choices may be the reasons for Dell's strong performance as a company.
Revenue Growth
Two years ago Compaq was nearly three times the size of Dell. With this quarter, Dell has come remarkably close to Compaq in size. When you compare the two revenue growth curves, shown below, its clear that Dell's continual upward climb is closing in on Compaq, which has lost its ability to grow every quarter.
Source: MarketGuide, Graph by Briefing.com
Most remarkable in Dell's press release was the statement that 50% of all growth in the PC marketplace was a Dell computer. It only requires a cursory look at the revenue growth shown by the other PC manufacturers to determine that is basically an accurate statement. .
Earnings Per Share Growth
Earnings per share has also been a continual uphill climb for Dell. Compaq's earnings are before any extraordinary charges.
It is important to note that you can't really make direct comparisons between raw earnings per share numbers, since all companies have different number of shares outstanding. The point of this graph is the trend of each company. Dell's is simply straight up, continually for the past two and a half years.
Source: MarketGuide, Graph by Briefing.com
Net Margin Growth
In one of the best measures of how good a management team is, Dell again shines. While the company has grown larger, the net margin has also grown. This means that not only is Dell bringing in more dollars, it keeps more of each dollar. This is the combination that every investor, Wall Street and Main Street, loves. Compaq on the other hand, has had a sharp drop in their net margins. Note that 1998 and 1999 are estimates by Value Line for both companies.
Source: Value Line, Graph by Briefing.com
Credit Goes to Strategy Decisions
Why is Dell able to deliver such good numbers?
We think it is primarily because of their intense focus on a single clear objective: direct delivery of high end PCs. Dell does not try to cover the entire market. They have completely avoided the low cost, sub-1000 PC market. While this means you don't see too many DELLs in domestic homes, it also means they don't have to build lower margin products.
In addition, DELL long ago abandoned all channels except the direct channel. DELL does not sell through retail channels and does not build inventory for resellers. Every DELL computer is built because it has been ordered. This keeps inventory incredibly low; Dell currently has inventory down to 8 days. Compaq suffered through serious inventory problems in late 1997 and early 1998 as the PC market slowed.
Dell's strategic direction in direct selling on the Internet, now at $6 million per day, or 12% of total revenue, has also been a strong playing card as it helps reduce selling costs. Dell's initiative to set up private, customized Internet ordering pages for corporate clients has a large upfront cost, but extremely low costs for repeat sales. This initiative makes it easy for a corporate departmental client to place an order directly with Dell. Once established, it should help retain the customer over time. As Internet selling grows, this should help continue Dell's upward trend in net margins.
Compaq on the other hand has pursued multiple objectives including retail distribution, value added reseller channels, and direct catalog sales. In addition, with its purchase of Digital, it will have many differing ongoing directions at the same time. It is simply harder for a management team to do multiple things. At Dell, they are very focused on a single, clear line of business. For now, that focus is paying off.
The Future for Dell
The PC market is rapidly becoming a commodity business. As the industry matures, there should eventually be fewer players, according to classic market theory. As the industry matures, the most efficient producers of commodities generally win. Dell currently has only 8% of the total worldwide PC marketplace. Even if the PC marketplace slows in growth, Dell should gain market share as a more efficient producer. In fact, if the PC marketplace shrinks, Dell's low inventory approach would give it a tremendous advantage over Compaq and most other producers.
In addition the Asian crisis is currently most likely a benefit to Dell, not a liability, as Dell consumes more from Asia in supplies then it sells as product. If Asia weakens economically, parts simply become cheaper for Dell. The net result is a gain.
The Future for Dell Stock
"Trends tend to continue." Aside from being a tautological truth, it is also usually assumed by Wall Street, until proven otherwise. Dell's stock has a built in premium over Compaq's, above and beyond the valuations based on earnings, which accounts for the assumption that Dell will continue to outpace all others in the PC marketplace.
If Dell's trend ever goes the other way, even in just one quarter's report, the premium will be taken out of the stock immediately, and the stock will probably fall, even if revenues rise and earnings increase. The rate of increase will be the item to watch. However, there currently isn't any reason to assume that Dell's strong upward growth curve will abate.
Conclusion
Like we said, it is hard to find something to criticize with Dell Computer Corporation as a business. The credit goes entirely to the management team and the efficient execution of a sound strategy. Although the stock price has a hefty premium built into it because of this, shareholders who have paid it over the past several years have been amply rewarded. As long as the Dell team keeps up the trends highlighted above, the trend of rewarding their shareholders will also likely continue.
Note: Graphs above show annual quarters. Dell's fiscal year ends in January. The latest reported quarter for Dell is Q2 of fiscal 1999, for the time period ending in July, 1998. Compaq's fiscal year ends in December. The periods are therefore not precisely comparable, but are still meaningful for the purposes of showing trends.
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