With Dell, the Herd Instinct May Be Right

Aug.22.06 | About: Dell Inc. (DELL)

The herd instinct can be a powerful force on Wall Street, but it's often as easy to get trampled as it is to run to the bank. We often find ourselves thinking contrarian thoughts when the whole market seems to have turned on a stock, as with Dell Inc.(NASDAQ:DELL), which last week rattled investors with a slew of bad news including a 51 percent decline in quarterly profit and a huge recall.

Sometimes the herd is right, though. Shares in the world's biggest personal computer maker have dropped 27.8 percent year-to-date, and our analysis shows the retreat may not be over.

At recent prices, using a historical beta of 1.15 and a price-to-earnings ratio of 17.7, an investment in the shares today would need to see annualized, per-share earnings growth of 11.7 percent to break even after five years. The average of 17 analysts who provide long-term earnings growth projections is 10.8 percent, in a range of 20.0 to 2.0 percent.

The 2.0 percent forecast -- - from Cindy Shaw with Moors & Cabot - seemed unrealistic to us at first. Consider that the 10-year Treasury note, which is riskless, yielded 4.96 percent on Aug. 22. That means that Shaw doesn't expect Dell's shares to keep pace with the riskless rate. Not surprisingly, she has a sell rating on the stock.

But three other analysts projected a long-term growth rate of 5 percent, and another forecast 5.4 percent. In all, seven of the 17 projected single-digit growth rates for Dell, with more than half of those putting Dell near the riskless rate.

Most of the bulls in the analyst survey didn't publish reports after Dell released its earnings last week. Only Brian Alexander, with Raymond James, reiterated his outperform rating in a note that morning. If anything, we'd consider the high end to be the shaky end of the projections spectrum. In any case, given the wide spread, we'd consider any Dell positions carefully.

At the time of publication, Paul DeMartino did not directly own puts or calls or shares of any company mentioned in this article. He may be an owner, albeit indirectly, as an investor in a mutual fund or an Exchange Traded Fund.

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