Richard, let me take your points one at a time.
1. DSO. Your calculation is correct, but you need to understand two subsidiary issues: a. Growth companies typically show expanding DSOs because more sales occur towards the end of the quarter than at the beginning. b. Seasonality factors are also at play here because the end of this past quarter coincided with a seasonally heavy buying time.
2. Cost of employee stock options. The problem with pegging them to market price of the stock is that it ignores the dilutive effect of the option. Let me give you a simple example. Suppose there are 10 MM shares outstanding for a company with a market capitalization of $1 billion. Suppose that management wishes to issue itself options for 1 million shares at $10 each. Now you would say that the cost to the company would be $90 million. I look at it this way. The capitalized value of the company following exercise of the option would be 1.01 billion, but there are now 1.1 million shares outstanding. Therefore, the value of each share is 1.01/1.1, or $91.8182. Therefore, the cost to the company is $8.18182 x 1 million shares or $8,181,200. The problem is that this cost is borne by the shareholder in the form of a lower price.
Yes also to you point about the tax effectiveness of stock option. But I believe that the major driver here is the fact that the accounting for this activity remains hidden.
3. Stock buy backs. Yes, these are efficient ways to distribute dividends because the "dividend" is tax deferred and converted into a capital gain. But stock buybacks do not add value. And they can be used to "enhance" perceived earnings. Here's an example:
Suppose we have a company with 100 million shares o/s with a price of $100 each. Suppose that the company has earnings of $5/share, and wishes to dividend $100 million. Before the dividend, the value of the company will be $10 billion. Following the dividend, the value will be $9.9 billion, and shareholders will have $100 million in their possession, so the value of the stock will be $99 per share. Now suppose instead that the company wishes to repurchase stock. The value of the company following repurchase will be $9.9 billion (because $100 million in cash is now gone), and investors will hold 99 million shares. So the value of each remaining share is still $100. This is exactly the point where the company was prior to the dividend. But earnings per share has increased because of the smaller share base. Now earnings appear to be $5.051 per share. Instant 5.1% growth! The fact is that earnings really aren't growing at all. This is just a case of dividend reinvestment without intermediate taxes to foul things up. So the enhancement to shareholder value is restricted to the tax treatment of the dividend, which, over time, is substantial.
So bottom line: I fully concur with your point about watching total earnings growth rather than growth in earnings per share. Even better, watch the growth in operating cash flow.
If you are planning to present Dell to your investment club I suggest you take the time to check the Motley Fool's archives. They have some very incisive discussions about Dell's business model. Also, some time ago there was a writeup about Tom Meredith and the cash conversion cycle which can give you some excellent insights into financial management of the manufacturing process. I suggest you contact Lee -- I think she has the URL for that. Finally, the Harvard Business Review published an in depth interview with Michael Dell, and this discussed the concept of virtual integration in a great deal of depth. I think jbn3 might be able to help you with that.
It is very difficult to be anything but enthusiastic about Dell after reading these sources.
Good luck!
TTFN,
CTC |
