Yesterday the company announced it is developing a smartphone in China using a software platform developed by Chinese search-engine operator Baidu Inc (BIDU). The smartphone is expected to hit the shelves in China early next year, after which DELL will look to launch the smartphone in other markets. DELL is shifting its focus not only to smartphones and tablets, but it has also been growing its enterprise solutions and service business materially in recent quarters.
DELL has grown its EPS from $0.46 to $1.35 over the past 10 years, representing an annual compounded increase of 11%. Over that time it has achieved a return on retained earnings of 8% which is not a great result. A company that cannot achieve a decent return on its retained earnings should consider the introduction of a dividend.
The formula to derive the Free Cash Flow score includes a provision for Free Cash Flow growth, which explains why DELL only scores 4 on its Free Cash Flow. Its Free Cash Flow generation over the last 10 years has been extraordinary, albeit at a small growth rate. It has generated over $33B in Free Cash Flow over the past 10 years versus total net earnings over the same period of over $24B.
DELL in its recent results – both annual results issued in Jan 2011 as well as the 3 quarterly results since then – have silenced their critics. They are producing some great numbers, making the forecast Intrinsic Value even more attractive than the existing. But the market still has its doubts – a decent Margin of Safety is currently on offer.
Coming out of the dot com bubble, DELL remained well over-valued. The share-price has gone sideways since then while the value tries to catch up. As can be seen, DELL’s performance suffered while it was slowly reacting to the challenges facing its simple PC business. But in fiscal 2011 the company started what looks to be a turnaround. Since the GFC in 2008, DELL’s share-price has been reasonably depressed and this year market has not given the company enough credit yet for its fiscal 2011 performance.
Investment Grade Score
With a Margin of Safety of 33 and a Quality Rating of 55, DELL achieves an Investment Grade Score of 33 x 55 ÷ 100 = 18. This places DELL at number 99 on the USAStockValuation.com Investment Grade Table.
If DELL struggles to achieve a decent return on retained earnings, the company may introduce a dividend. Let’s look at 2 scenarios, and let’s assume the fiscal 2011 EPS performance can be maintained into the future.
- Scenario 1: A Payout Ratio of 50%: The dividend yield based on the current share-price of $14.68 would be 4.6%.
- Scenario 2: A Payout Ratio of 75%: The dividend yield based on the current share-price of $14.68 would be 6.9%.
With declining PC prices, and stiff competition to its traditional business model, DELL is starting to reinvent itself with its new offerings. The company is achieving significant growth in its enterprise solutions and service offerings, and is entering the tablet and smartphone markets, all providing encouraging upside potential. And the company generates extraordinary Free Cash Flow which limits the downside risk (cash flow provides flexibility for a company - pay dividends, buy back shares, acquire other businesses etc). Many investors will find the downside risk versus upside potential for DELL attractive at current prices.