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QUALIPORT
Dell Gets The Boot

By Maynard Paton (TMFMayn)
January 29, 2001

Carburton Street, London -- The time has come to end the Qualiport's involvement with Dell Computer Corporation (Nasdaq: DELL). In accordance with the Fool's Trading Rules, the Qualiport will dispose of its entire Dell holding within the next five trading days. Overvaluation has prompted this announcement, alonsgside a personal dislike for small portfolio holdings.

Dell hell

To recap, Dell shares have been the Qualiport's worst ever investment. Bought two years ago at $44.625, Dell's stock plunged during 2000 after the company consistently warned of lower-than-expected revenues. The trend continued into 2001, when, last week, the company warned that its current fourth quarter performance would be below forecasts. At Dell's current stock price of $26.5, the Qualiport has suffered a 40% loss on the original purchase. The perils of investing with very high expectations built into your purchase price (Dell traded on a prospective price to earnings (P/E) ratio of 78 when bought) have been for all to see.

The latest profit warning

In a nutshell, Dell's latest announcement informed us that fourth quarter sales would be between $8.5b and $8.6b (previously $8.7b) and earnings per share (EPS) of $0.18 or $0.19 (previously $0.26). Dell blamed the shortfall on the "deterioration in global economic conditions and overall demand for computer systems and services." During a conference call to discuss the latest statement, Dell refused to provide any "guidance" beyond the current quarter. The company will provide the outlook for the remainder of 2001 within its full-year results announcement on February 15th.

After the latest statement, revised EPS forecasts for the year ending January 2001 are now concentrated around the $0.845 mark (previously $0.92), while EPS estimates for the year after average $0.91 (previously $1.08).

At $26.5, Dell's stock stands on a prospective P/E of 31.3, falling to 29.1 for the year to January 2002. A pretty racy valuation, given that earnings growth is expected to be around the 8% level in the next fiscal year. All in all, there's just no safety net should Dell disappoint any further. While the PC industry's turmoil will probably see Dell's lowest-cost business model win out in the end, it's far from certain the current cheery rating justifies the tough times ahead.

Other income

Another valuation point to consider is Dell's "financing and other" income. In the past couple of quarters, 15% of Dell's EPS has consisted of either interest receivable or gains made from investment disposals. Comments made in the conference call implied that the level of non-operating profits would continue at the present level.

Given the deterioration in operational performance, it's a fair bet that Dell's reliance on "financing and other" income sources will increase further. However, these "other" sources just don't deserve a premium growth rating. To justify the company's current valuation, putting non-operational EPS on an average rating obviously places Dell's operational EPS on a rating greater than the overall level of 30.

Alongside the general valuation concerns, there's also the fact that Dell currently makes up only 5% of the Qualiport. Not a reason for selling on its own, but as I've experienced in the past with Unilever (LSE: ULVR), a troublesome holding representing only a small part of the portfolio can be very distracting.

Pay up for quality?

So, what can the Qualiport learn from its encounter with Dell? It's pretty much summed in the feature Great Company, Bad Stock. Pay too much over and above a company's intrinsic value and no matter how great the fundamentals are, you'll underperform.

As a business, Dell had it all -- great cash flow, return on equity, industry leadership, proven management and so on. And although those characteristics are still in place, in retrospect, they were all in the purchase price. A deteriorating PC market then knocked the stuffing out of the Qualiport's original growth forecasts and the portfolio paid heavily.

To end, beware of using the phrase "you have to pay up for quality" to justify any purchase of a highly rated company. If a pre-eminent operator like Dell can stumble, then there's a fair chance most other companies possessing rosy valuations will create similar investment disappointment.

Your turn

A simple poll to judge the investment merits of Dell. At a share price of $26.5, what's your view of Dell?

* Buy
* Hold
* Sell
* I don't know/care

Click here to vote.

Where next?

The Qualiport and Dell -- the story in full.

* Fool Buys Dell
* Delving into Dell -- Full year 2000 and Q1 2001 results reviewed
* Unwell Dell -- Q2 2001 results reviewed
* Sell Dell? -- Dell's deteriorating return on equity performance highlighted
* Dell Hell -- Q3 2001 results reviewed
* Worrying thoughts over Dell's Q3 2001 performance