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Strategies & Market Trends : Buffettology -- Ignore unavailable to you. Want to Upgrade?

To: Tomato who wrote (732)	12/23/1998 4:54:00 PM
From: jhg_in_kc	Respond to of 4691

I would be glad to. Go to the Dell Facts thread and read the "Harvard Business Review" article interview of Michael Dell "Virtual Integration." Its about post 23 or so I think. Later if you have any questions do not hesitate to contact me. Dell's business model is so efficient it is a barrier to entry to the competition because in theory it could be copied but in reality no one can afford to do it. good luck jhg

To: Tomato who wrote (732)	12/23/1998 8:08:00 PM
From: Chuzzlewit	Read Replies (3) \| Respond to of 4691

Yes, I can. First forget P/E because it is like driving a car with your view provided by the rear view mirror. The P/E concept was devised by Ben Graham as shortcut for valuation. It works well enough for stocks that aren't growing, but it is pretty dismal for growth companies. Here's why: First, the mathematics of P/E A P/E is really just a mathematical inversion of a yield, in this case a stock divided by a flow. Now a flow has an implicit denominator, time, but a stock has none. It is a snapshot in time. So, the problem is that since time is of the essence in growth, the P/E loses whatever validity it might have for slow or no-growth companies. Put another way, what is the validity of looking at last year's earnings divided by this year's price. Put another way, you would never look at putting money in a bank on the basis of last years interest rate, so why would you do it with a stock. Forward P/E's are frequently used to get around this problem. It is a better approach but again the same criticism holds sway: it does not capture the value of the full stream of future cash flows. It simply and artificially focuses on only the coming year. So, to evaluate a company like Dell, or for that matter any growth company, you need to have a metric that quantifies all of the future free cash flows. Now to Dell's business model: Dell is unique in the manufacturing world in that it is able to rapidly convert a sale into cash. It does this by closely integrating several business functions: A/R, A/P, inventory management, manufacturing, and delivery. As a resultof efficiencies of manufacturing and integration with suppliers, it is able to keep inventories at an astonishingly low level. Currently, DELL maintains about 7 days of inventory. In addition, striking excellent deals with suppliers allows DELL about a month and a half of time before it needs to pay for those parts, and last I looked, it was receiving payment from customers in a little over a month. This adds up mathematically to a net receipt of cash before the order is received. The concept is embodied in what Tom Meredith calls the Cash Conversion Cycle, or CCC. As a result of these efforts Meredith was recently named CFO of the year. The practical consequence of this is that the company is able to achieve sustainable growth of over 50% per annum without recourse to external financing. Put another way, it achieves ROIC of around 200% per annum because of the efficiency of the deployment of assets. But the story doesn't stop there. Use of the internet creates a sales force with only fixed costs, and it is almost infinitely extensible. Major customers like Boeing get their own dedicated web sites. Furthermore, Dell provides value-adds to customers that are truly amazing. At a nominal cost ($25 per machine) Dell loads whatever software the customer wants on location tagged machines. This is a huge selling point to major corporations. Finally, Dell uses share repurchase as a tax efficient surrogate for dividends. Michael Dell estimates that hyper-growth for computers will continue at its current pace for another three to five years, at which point growth will slow to a measly 15% (industry average). So Dell hasn't stopped there. It is currently adding (and fueling) future growth with mass storage devices, and I expect that the company will continue to expand its product offerings, thus further extending the envelope of hypergrowth. One last item you should be aware of: the barrier to entry is very real because it requires jettisoning intermediate channels of distribution. But to do that you run the risk of the former channel "partners" running out and selling your competitors gear. CPQ and HWP and IBM have been unsuccessfully trying to do that for years. I suggest you read the Harvard Business Review article that jhg cited as probably the best overview of the company. This is a company that bears considerable study. Now back to the valuation issue. DELL may earn around $1.60 next year, giving it a forward P/E of around 44. Conservatively speaking, Dell has a five year growth rate estimated at around 40%. The S&P has a forward P/E of around 24 with a long-term growth rate of around 11% (looking past the current year). What I do is calculate the YPEG for the S&P and divide that number into the YPEG of the target stock to give me a normalized PEG (so-called CNPEG). If you do this you get a CNPEG for DELL of around 0.50. The interpretation of that metric is that you can buy growth through DELL at roughly 50% of what it costs in buying the S&P. How's that for value? Sorry about the long-winded nature of the answer, but DELL is a truly unique company. TTFN, CTC