Two powerful trends are shaping the opportunity to profit from tech stocks, and one of those stocks should be Dell (NASDAQ:DELL).
The first is a change in the mix of technology spending from consumers to companies.
And the second is the popularity of Apple’s (NASDAQ:AAPL) iPad — 20 million have been sold since its April 2010 introduction. Neither trend is likely to reverse soon.
Over the last two decades, the leading source of technology spending has changed hands a few times. During the 1990s, there was a boom in corporate technology spending as companies upgraded their computing infrastructures to compete in e-business.
A vast amount of companies bought PCs online from Dell. As I wrote last June, its value chain let Dell set its costs 14% below those of competitors like Compaq (that Hewlett-Packard (NYSE:HPQ) bought in 2002) while charging companies a 13% higher price because of the convenience its preconfigured-PC, online purchasing process offered.
During the last decade, companies lost interest in IT as a source of competitive differentiation and focused on trying to make it more efficient by shifting basic functions to lower cost countries. PC growth came from consumers, who like to buy PCs after checking them out in retail stores.
Dell’s strength selling to companies became a weakness when it came to consumers — and Dell’s market capitalization fell $68 billion as a result.
Last year, Apple introduced the iPad and to my surprise, it has become a huge hit — at least a decade after Microsoft (NASDAQ:MSFT) then-CEO, Bill Gates, walked around talking about the benefits of tablet computing.
Now we’re seeing the iPad cut into sales of PCs for consumers, which is hurting H-P the most. Overall, the PC market is shrinking at a rate of 3.2% globally and 10.7% in the U.S.
Meanwhile, after a year of record corporate profits of $1.68 trillion and nearly $2 trillion in balance sheet cash, companies are finally beginning to spend more on technology after holding off for much of the previous decade. For example, in the first quarter of 2011, U.S. GDP growth was a slim 1.8%, but that weak performance masked a much higher 11.6% spike in corporate technology spending — a boom to Dell.
These trends help explain why Dell did well in the first quarter. Dell said late Tuesday that it beat analysts’ estimates because of corporate demand — where it has traditionally done well — while its sales to consumers fell 7.5%. Meanwhile tablet sales, the iPad and others, are expected to climb at a 52% compound annual rate from 70 million in 2011 to 246 million in 2014.
Does this mean you should buy Dell shares? To help with that decision, we can look at its price-to-earnings-to-growth (PEG) ratio — a way to determine whether the value that the market assigns a stock is justified by the rate at which it expects the company’s earnings to grow. I think a PEG of 1.0 is a fair price, and anything below that is a bargain.
Based on PEG alone, I’d avoid Dell. That’s because its PEG of 2.45 looks overpriced — its P/E ratio is 11.8 on earnings expected to grow 4.8% to $1.76 a share in 2012.
I may be going out on a limb here but based on Dell’s earnings growth in the first quarter to 55 cents a share (beating estimates by 10 cents), I think the 4.8% 2012 growth forecast could be way too low.
Tablet growth is going to be strong in the years ahead but it remains to be seen how strong it will be in the corporate market. Nevertheless, it wouldn’t hurt if Dell could offer a compelling corporate tablet — its Streak currently controls a tiny 3% of the market — in a decade during which companies are likely to boost their IT spending dramatically, Dell’s stock should benefit.
Peter Cohan has no financial interest in the securities mentioned.
