With the broader stock market selling off heavily over the past month, new opportunities have arisen as always. It's important to note that the only fundamental that has changed for companies that have dropped in price is their projected long-term earnings power. If a stock gets significantly cheaper but the earnings power (and normal rate of return/discount rate) hasn't changed, you've got yourself a potential opportunity.
One stock that has dropped to 52 week lows is Dell (DELL); largely a result of an earnings report that displayed a tough quarter, and a stock market that has been under pressure stemming from worries about Europe.
Misunderstood Business
In that earnings report, full 2013 fiscal guidance was actually reiterated to be above $2.13. At current prices, Dell is trading at 5.8 times earnings. Of course, Dell has more than $2 per share in net cash, so the stock is really trading at a price to earnings multiple of 4.85 times earnings.
A mature, consumer hardware/PC company trading at 5 times earnings would not be crazy, but Dell is not that company. At least 50% of revenues come from businesses that are not related mobility or desktop PCs, which is a very mature business.
- Services and Networking: 13% of revenues (and growing rapidly)
- Storage: 3%
- Services: 13%
- Software: 17%
Management's goal is to attach high-value software to their hardware units, notably management of data and devices in the mobile segment.
This software business has led to solid margin expansion, with gross profit margins coming in at 23.4%.
Additionally, even though it appears the market is assuming the PC/consumer hardware business to be completely dead, sales have been extremely strong, and margins expanded from 15.9 to 20.5% in 2012 as higher-value products were sold. Sales of Dell's Lenovo helped Dell obtain 13.1% of the PC market in Q1, and niche products like the XPS are driving margin expansion further.
New signings for Dell's server business were up a massive 80% over the past 12 months to $1.8 billion, which is indicative of a major catalyst for a high-margin earnings driver.
With a significant portion of revenues coming from an enterprise solutions business that a strong brand name like Dell can compete in, and the rest coming from consumer hardware, where Dell is obtaining a high-value, higher margin niche with solid pricing power, this sort of a valuation makes little sense long-term.
Conclusions
EPS in 2010 was $.73, while 2013 EPS will likely come in at $2.13. This kind of earnings growth in the midst of a major operational transformation is quite impressive.
While shareholders have been angry at the inability of share repurchases to "support" the stock, the reality is that shares outstanding have decreased from 1.96 billion in 2010 to 1.75 billion as of the most recent quarter, with a decent portion being bought recently at excellent price to value ratios.
Now, with a 2.6% dividend declared, investors are looking at an outrageous forward earnings and dividend yield of 20%. This figure appears in line with my expected annualized return over the next 3-5 years.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in DELL over the next 72 hours.
