Dell a Steal at Current Prices (DELL)

May.18.06 | About: Dell Inc. (DELL)

I'm going to do some simple calculations and discussion to explain why Dell (NASDAQ:DELL) is actually an excellent company at a bargain price...

Step 1: FCF/EV yield vs. Treasury yield

Enterprise Value [EV] = $49.1B

Free Cash Flow [FCF] = $4.1B

FCF/EV yield = 8.35%

Treasury yield (30 years) = 5.30%

Dell looks like an excellent deal when compared with treasury yield.

Step 2: Insider holdings

I have mentioned about strong returns by investing in founder-CEO companies. Investing in companies that have significant insider holdings is one of the great ways to achieve strong returns.

Michael Dell has holdings of over 10% of Dell. On top of that, he is still young and has great enthusiasm to expand Dell’s empire.

To read my previous comment on insiders holding, click here.

Step 3: Is Dell a good Company?

Profit Margin: 6.39%
Operating Margin: 7.96%

Return on Assets: 12.01%
Return on Equity: 67.31%

Dell has a good Return on Assets.

Step 4: Is Dell management shareholders-orientated?

Dell has been buying its own shares aggressively; purchasing up to $6.2B, which is more than its income of $3.57B. Over the last 3 years, Dell has repurchased over $10B worth of shares, and with its current low price, I don’t see why Dell will stop repurchasing its shares even more furiously. Buying back shares is an important step to enrich shareholders, as long as it doesn’t restrict its financial ability to expand and improve its service.

Step 5: Do you understand its business?

Dell was founded in 1984 by Michael Dell, the longest-tenured executive to lead a company in the computer industry. The company is based on a simple concept: by selling computer systems directly to customers, Dell could best understand their needs and efficiently provide the most effective computing solutions to meet those needs.

This direct business model eliminates retailers that add unnecessary time and cost, or can diminish Dell's understanding of customer expectations. The direct model allows the company to build every system to order and offer customers powerful, richly-configured systems at competitive prices.

Dell also introduces the latest relevant technology much more quickly than companies with slow-moving, indirect distribution channels, turning over inventory every four days on average.

[From: Dell's website]

Step 6: Does Dell have a moat?

Moats come in different forms. As for Dell, its moat is being the lowest-cost producer of a particular commodity, in this case computers. Dell has done extremely well with its supply chain and direct model and it is hard to fathom the emergence of possible competitors.

Do you know how strong its working capital management is? Very, very strong. Dell has negative working capital! That’s right, it has a minus $4.6B of working capital. There aren’t many companies that have a negative working capital.

Step 7: Does any superinvestor invest in Dell?

Without a doubt, there are several famous superinvestors investing in Dell. Among them are Mason Hawkins (7.18% of assets), Bill Miller (0.87% of assets), and others. Mason Hawkins believes so strongly Dell is undervalued that he makes Dell its biggest holding.

Step 8: What are the potential risks in buying Dell?

“Our biggest worry is the competitive climate in the desktop PC market. Asian firms have often endured break-even margins to generate growth and could induce an irrational pricing environment in their quest for market share.” [From the Morningstar Report]

Conclusion:

Dell is a steal at its current price of $25.20.

As Warren Buffett said:

“The most common cause of low prices is pessimism -- some times pervasive, some times specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It's optimism that is the enemy of the rational buyer.”

DELL 1-yr chart:

DELL 1-yr