Computer maker Dell inc. (DELL, Financial) is in the portfolios of many value gurus we track. DELL stock is traded at 40% lower than it was 10 years ago, and 60% lower than its all time high in 2005. With today’s close of $15.72, P/E at around 11, Dell does look cheap.
As all long term value investors know, buying stocks at cheap does not necessarily makes you money. A cheap stock can get even cheaper, if the business fundamentals have deteriorates. This is so called “value trap”.
How do you avoid falling into a value trap? As written by our distinguished columnist Geoff Gannon, “You can use something called the F-Score. The F-Score was created by an accounting professor at the University of Chicago. He wanted to use a simple checklist to separate troubled companies from companies that were going to pull through … It’s a list of 9 different questions that can be answered yes or no. If you answer them yes it counts as a 1 and if you answer them no it counts as a 0. It’s basically an on/off switch. You tally up the score and see how the stock does. Most stocks score somewhere between 3 and 7. A few get very low scores like 0, 1, or 2. And a few get very high scores like 8 or 9...”
Among the 9 questions of calculating the F-Score, question number 8 is the change in gross margin. If this year’s gross margin is higher give the stock one point. If last year’s gross margin is higher give the stock zero points.
While F-score is useful, we believe that one reliable way is to look at the long term trend of the gross margin. This can be easily done with the 10-year financial charts at GuruFocus. For instance, in the case of DELL, please go to Dell 10-year financials page. In the area of ratios, click on the line of Gross Margin, We see the history of the gross margin of Dell:
As all long term value investors know, buying stocks at cheap does not necessarily makes you money. A cheap stock can get even cheaper, if the business fundamentals have deteriorates. This is so called “value trap”.
How do you avoid falling into a value trap? As written by our distinguished columnist Geoff Gannon, “You can use something called the F-Score. The F-Score was created by an accounting professor at the University of Chicago. He wanted to use a simple checklist to separate troubled companies from companies that were going to pull through … It’s a list of 9 different questions that can be answered yes or no. If you answer them yes it counts as a 1 and if you answer them no it counts as a 0. It’s basically an on/off switch. You tally up the score and see how the stock does. Most stocks score somewhere between 3 and 7. A few get very low scores like 0, 1, or 2. And a few get very high scores like 8 or 9...”
Among the 9 questions of calculating the F-Score, question number 8 is the change in gross margin. If this year’s gross margin is higher give the stock one point. If last year’s gross margin is higher give the stock zero points.
While F-score is useful, we believe that one reliable way is to look at the long term trend of the gross margin. This can be easily done with the 10-year financial charts at GuruFocus. For instance, in the case of DELL, please go to Dell 10-year financials page. In the area of ratios, click on the line of Gross Margin, We see the history of the gross margin of Dell: