Has Dell lost its edge?
Investors may be making a mistake if they give up on Dell and turn to stocks like Hewlett-Packard instead.
NEW YORK (MONEY) - Dell reported a 52-percent gain in fourth-quarter net income last week...and the stock price promptly fell by almost 5 percent. Despite strong profits, other parts of Dell's report were disappointing.
Profit margins were down and earnings weren't as good as they first looked after taking into account special factors. In addition, Dell's guidance for the current quarter was cautious.
Investors have been losing their enthusiasm for the world's largest computer maker for more than a year. Since January 2005, Dell shares have lost 28 percent of their value.
As a result, lots of tech investors are taking a shine to other stocks, such as Hewlett-Packard. Selling Dell and putting the proceeds into Hewlett-Packard when new CEO Mark Hurd took over in March 2005 would have been a bold bet that Hurd would be able to engineer a comeback for the depressed stock. And it would have paid off -- H-P stock is up 70 percent since then.
Today, however, both companies' prospects are fairly reflected in their share prices. Dell may lag for another quarter or two, while H-P may continue to generate larger-than-usual profit gains through cost-cutting. But what really matters is which company is better positioned for long-term growth.
Easy gains are over
I've never been all that much of a Dell fan. For years, the company outpaced most other computer makers by competing aggressively on price and grabbing market share. But as prices for PCs have come down, it has been harder to undercut competitors without badly hurting profit margins. And as Dell has dominated more of the market, it has become more difficult to take additional share.
H-P has been the opposite story. More than three years of weak performance had left the company with undervalued shares and plenty of ways to cut costs. When an aggressive new CEO took over, there were clear opportunities to boost the share price.
But you can't invest today on the basis of what would have happened if you had made the move almost a year ago. And unless you're a professional trader, you shouldn't focus too much on prospects for the coming quarter. So how do the stocks' long-term prospects compare?
The recent environment has been tough for Dell. Consumer spending in the United States has been restrained, and there aren't a lot of innovations to pump up PC sales. But that could change for the better if there's a general upturn in tech spending or new software to encourage computer upgrades. Dell is also developing more powerful PCs that would have bigger profit margins.
Equally important, Dell is doing quite well in its other businesses. Domestic sales of servers and storage equipment rose more than 20 percent in the most recent quarter, and so did overall foreign sales. Not only are revenues from outside the United States faster growing, they also account for 43 percent of Dell's business. And because Dell has a smaller slice of the market in foreign countries, it's easier to pick up share.
Both Dell and H-P are generating more cash than they need, and using some of it to buy back stock. But a crucial part of H-P's recent gains has come from cost-cutting. And there's a limit to how long that can pay off.
It certainly makes sense to recognize that from here on, Dell will likely grow in line with the overall industry. And if the share price still carried a huge premium, that would be grounds for being bearish on Dell. But the stock's price/earnings ratio today is reasonable.
Expectations are now relatively low for Dell (Research), but somewhat high for Hewlett-Packard (Research). That may be based on the performance of the two companies over the past year, but it doesn't accurately reflect future prospects.
At $30.38, Dell trades at 18.3 times estimated earnings for the current year. H-P is on a fiscal year, but for calendar 2006, it's trading at a P/E of just over 17. Moreover, while Dell is still expected to match the industry, H-P is projected to lag with only 12 percent compound annual earnings growth, especially after cost-cutting is completed.
My own preference would be to invest in tech through an index fund or a growth fund, since individual companies are always unpredictable. But if I had to choose between the two stocks, I'd be inclined to bet that H-P will exhaust its opportunities, while Dell could soon be poised for a comeback.
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