Chuzzlewit, Excellent post. When I read the Barrons article the book value argument blew me away, so to speak. The arguments against Dell stock in this article are numerous. I will try to summarize these arguments made against Dell below so that you or other members of the thread can more conveniently respond to them.
This argument against Dell goes something like this:
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Dell, along with names such as Microsoft, Intel, Lucent, Cisco, and Compaq have become the "Nifty Techies". Money has flowed into these since the smaller techs have gone down, and these are now viewed as "safe havens". This has lead to overvaluation, a disconnect between the stock price and the fundamentals. Also mutual funds such as Legg Mason Value Fund, and Janus Twenty have about 10% of their value in Dell, and this adds to the risk. What is likely to happen is something similar to the 70's during the liquidation phase of the bear market, a sudden sharp loss of market value.
The idea that PC sales will pick up in the second half is wrong. The whole world is slowing, not just Asia. There are no strong drivers to PC sales, Windows 98 was not a strong driver, Windows NT won't have any impact until the year 2000. A big problem is too much capacity, and this can cause a slowdown without rising interest rates. Dell stock price does not have the risk of a recession factored into it.
Dell's recent market cap of $80 billion is large compared to the PC industry annual sales of $160 billion. When Dell goes down it will be fast, like with Amazon.
In buying Dell now, one is buying the concept that its earnings will grow at 50% or more forever. This will not happen, it will slow down. When this overconfidence ends valuation will again be important. This is a big problem for Dell because there is almost no book value. Most of the money earned in the last decade which should have accumulated in the form of some sort of assets has been used to buy back the most inflated stock in this inflated stock market. The stock options to executives amount to a sort of looting of the assets.
In the past stocks have traded at about 2 to 3 times book value. In 1995 Dell's stock was at about $3.00 and its book value was almost $1.00. The book value of Dell now is about $2.30, vs. a share price of over $100.00. It is trading at almost 50 times book value. If the confidence in Dell ends, and Dell ends up priced like PC companies were in the past, the price of Dell will drop to something close to book value.
Although it is thought by many that Y2K will help PC makers, there is no evidence of this yet in the numbers. Overall there it does not seem like a good idea to own stocks until the year 2000. There will be dislocations in dealing with Y2K and a recession is likely. In late 99 or early 2000, however, there may be great buying opportunites, so one is better off sitting out the time until then. Go for the 5% safe return and come back in 15 months.
My Thoughts:
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It is a judgement call as to whether or not Dell is overvalued. In the past is was very undervalued. I don't think the book value argument is valid, as you pointed out in your post. However, I am surprised that Dell was valued at 3 times book value in 1995. As you pointed out in a previous post, Dell seems cheap relative to the S&P if one considers expected growth rates (Current data per Yahoo "Detailed Research": Dell price of $109.5, earnings of 2.07 (Jan 99) gives a PE of 52.9, five year earnings growth estimate of 30.2% (perhaps too low), vs. for the S&P a PE of 20.6 (Jan 99) and a five year earnings growth estimate of 7.4%)
I don't think the fact that Legg Mason and Janus 20 have large positions in Dell is a problem. They won't be getting larger than the 10% limit, however.
I think Y2K will increase PC sales for Dell, and that it is too early to see this in the numbers. I think the growth of the internet, the need to increase efficiency at companies to compete well, and also the European monetary union conversion are big pluses for Dell and for PC sales overall. I am not sure how much PC sales overall will increase in the near future, but we are coming into the Christmas season when sales are usually strong.
As for the problem with Dell buying back its stock and giving out stock options, I don't fully understand this argument. Perhaps you or someone else could enlighten me on this one.
As for an overall market drop due to Y2K, I think this is likely to happen, but I think it is just as likely that it will not. There seems to be a wide range of opinions on this one. I recall a tech expert on Wall Street Week a while ago suggesting that if one is concerned about Y2K they should simply stay out of elevators on Jan. 1, 2000, implying that it will not be a big deal. I may increase my cash level a bit as a hedge against a market drop due to Y2K.
Please respond with any comments regarding the above.
Best,
John |
