The Dell Decline
Dell is a stock that I looked at in 2006 and failed to understand how it could possibly be priced at about 10 times the book value of its assets, along with a few others in the technology sector.
So, what does Dell do? The selling of computers is the main business. So, what you have is a company that is having to deal with the mature part of the business cycle. In my adult life we have seen society change from personal computers essentially were non-existant to a vast majority of homes, and indeed individuals owning one.
We have also seen massive upgrades to the computer industry. I think my second computer was probably 10-20 times more powerful then my first computer, and my third computer was probably 3-5 times more powerful then my second computer, and even my newest computer was probably 2-3 times more powerful then the one before. But, the time I have owned each computer has been longer than the previous. I think I went about 6 years on my last computer, compared to 2-3 years on my first.
When I looked at Dell I did not have my newest computer and my existing computer was about 5 years old. I simply did not have that burning drive to upgrade my computer because newer computers were so much better. Early in the computer industry every newer computer that hit the market vastly out performed the existing computers. Where performance could be doubled or tripled in mere months, now a 10% improvement might take a year, or at least that is how I perceive it. People tend to have computers that do everything they need and their computers are not becoming obsolete to do thing or run some programs as quickly as they did in the past.
So, first Dell was selling to essentially a new market, and then there was an enormous replacement market which I can't see possibly ever returning to past levels due to computer technology being in a far more mature stage of its development as well.
Well, gee, don't think a company priced at about 4-5% earnings when earning are as good as they can ever be is going to be over priced? And I think that is about where Dell was when I looked at in 2006. Unlike in the early 90s when Dell could probably count on 90% consumers to be interested in replacement computers in 2-4 years, I tend to think the computer replacement market has stretch to 3-10 years.
So... you think emerging markets are going to keep computers strong? Well, how profitably will these computers priced at $4-500 be compared to the computers in the 90s priced at $2-3000? I'd be willing to bet you have to sell 10-20 of them to even begin to compare to the profits of selling one of the old ones.
Right now Dell looks attractive in terms of it P/E (7.86), and it is priced at about 25% of its peak. Additionally, there are fewer shares out there so its market cap is probably currently an even smaller percent of its market peak. But, I tend to think that P/E ratio will look less attractive over time. I think Dell is priced at about 40% of where it was when I first looked at it in 2006. To me, it is interesting to see downgrades on the stock now. While for the reasons given I expect Dell to have a difficult time to increase or even maintain earnings over the longer term, I tend to think that Dell's earnings will find a new, lower maintainable earnings range.
Would I buy Dell? Probably not, but nor would I think you were nuts to buy Dell now, whereas those were my thoughts in 2006. I actually think Dell is not a bad looking stock right now. It looks to me like it has already priced a lot or even most of the declines in profits into it already.
In tough economic times replace a computer is going to go way down the priority list, but when a recover comes there will be pent up replacement demand.