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Goldman Sachs upgraded its rating on Dell (NASDAQ:DELL) to Buy from Sell, also increasing its price target from $10 to $13. This upgrade resulted in a premarket hike in Dell's stock price on Monday and also today. I believe this upgrade could not have come at a better time, considering the Windows 8 effect is just around the corner and Dell has extremely cheap valuations. I agree with GS and recommend investors buy dell for its limited downside, capital appreciation opportunity due to Windows 8, and extremely cheap valuations.

The PC market has seen a couple of rough years, primarily because smartphone growth has seriously depreciated the progress of the PC computing industry. According to Gartner, this was the first year since 2012 that the PC industry has shown negative growth. The problems of Dell are just not limited to the slowdown in PC industry. The company is also losing its PC business to Hewlett-Packard (NYSE:HPQ) and Lenovo. As the table below shows, the market share of Dell has declined from 11.2% to 10.5%, with the primary gainer being Lenovo. The industry average shipment decline has been -8.3% year over year, but Dell's decline has been more accelerated at -13.7%.

Preliminary Worldwide PC Vendor Unit Shipment Estimates for Q3 2012 (Units)

Company

Q3 2012 Shipments

Q3 2012 Market Share (%)

Q3 2011 Shipments

Q3 2011 Market Share (%)

Q3 2012-Q3 2011 Growth (%)

Lenovo

13,767,976

15.7

12,536,756

13.1

9.8

HP

13,550,761

15.5

16,217,987

17.0

-16.4

Dell

9,216,638

10.5

10,676,513

11.2

-13.7

Acer Group

8,633,267

9.9

9,616,572

10.1

-10.2

ASUS

6,380,690

7.3

5,708,807

6.0

11.8

Others

35,954,748

41.1

40,683,666

42.6

-11.6

Total

87,504,080

100.0

95,440,301

100.0

-8.3

Source: Gartner.

The valuations for Dell, however, remain very attractive. As can be seen below, the forward and trailing P/E are approximately three times below the industry average. The price/sales ratio is similarly three times below industry averages, and the price/book ratio is 30% under the industry average.

Dell

Industry Average

Trailing P/E (ttm, intraday):

7x

18.0x

Forward P/E (fye Feb 3, 2014)1:

6.2x

18.0x

PEG Ratio (5 yr expected)1:

1.0x

N/A

Price/Sales (NYSE:TTM):

0.3x

0.9x

Price/Book (mrq):

1.7x

2.2x

Source: Reuters, Yahoo Finance, and Bloomberg.

Goldman Sachs Upgrade

GS upgraded its Sell rating on Dell to Buy, moving its target price from $9 to $13 -- a 44% increase. GS has increased the target due to a number of different reasons. The primary reason behind the upgrade is its assumption that the market has already priced in the slowdown in the PC industry. While this might be true, Microsoft's (NASDAQ:MSFT) Windows 8 will increase PC shipments in this quarter. The last Windows upgrade was approximately five years ago and PC users have been holding off purchases for Windows 8 -- that should impact quarterly figures. The initial sales of Windows 8 have not been good, but it's still too soon to tell if the product will fail to jump start PC growth.

The other primary reason for the upgrade seems to be the large cash hoard Dell has saved up. The company has approximately $ 5 billion in cash, which comes down to $2.8 per share -- approximately 30% of current price. This limits the downside to Dell and also allows the company engage in M&A activity and create opportunities for growth.

Conclusion

Dell is trading at extremely cheap valuations, and I agree that the bad conditions in the PC industry have already been priced in. It's high time that Dell uses its large cash store to make strategic acquisitions. The company can increase dividends due to its large cash reserves, but the dividend yield is already decent at 3.2% -- i.e., 40% above industry average. The consensus EPS estimate for 2013 is $1.71, which gives us a target price of $30. That goes to show how the extreme undervaluation of Dell by the market. I believe the upgrade could not have come at a better time with the Windows 8 effect on the PC industry just around the corner. I would like Dell to either speed up its M&A strategy or focus more on returning cash to investors through buybacks and dividends.

Source: Goldman Sachs Upgrades Dell - Why Now?