One of the world’s most successful investors is suddenly hot on technology. But Warren Buffett’s $10.7-billion (U.S.) passion for International Business Machines Corp. doesn’t signal that the IT sector is a smart haven for all investors.
On Tuesday, just a day after Mr. Buffett revealed that he had amassed a 5.5-per-cent stake in one of the world’s most respected technology companies, another industry bellwether delivered another quarter of zero growth.
Dell Inc. said sales of $15.4-billion were flat in the third quarter, compared with a year earlier, and that annual growth would be at the low end of its guidance of between 1 per cent and 5 per cent. The shares immediately fell 2 per cent in after-hours trading.
While Mr. Buffett likes stocks with a wide defensive moat around their business, Dell is exposed to all the risks – and potential rewards – of a major corporate transformation.
It is facing a number of headwinds that have sent investors to the sidelines. The company has high exposure to government spending at a time of widespread cutbacks. It has also seen rival Apple Inc. shift the ground beneath its feet by creating the tablet market, which is eating into the once-hot netbook PC segment. Last quarter, Dell’s sales to consumers fell 6 per cent.
Where Mr. Buffett was attracted to IBM by its stable performance and well-ensconced position as the leading provider of services and hardware to businesses, investors following Dell have discounted the shares due to uncertainty about the company’s future.
Dell shares trade at just eight times future estimated earnings. That compares with a price to future earnings multiple of 10 for Apple and 13 for Lenovo Group Ltd.
The Round Rock, Tex.-based company is clearly in transition, as the founder and chief executive officer Michael Dell steers it into the more lucrative markets of servers, storage devices and IT services for businesses. Dell reported a year-over-year increase in sales of 8 per cent in this area, to a record $4.7-billion.
These results helped Dell beat the Street’s earnings expectations and deliver its seventh consecutive quarter of higher margins. The company posted a 9-per-cent rise in profit, to $893-million. Gross margin improved to 22.6 per cent from 19.5 per cent.
Most impressively, Dell again showed that it is a cash machine, generating $1.1-billion in operating income. Over the last 12 months, operating income has amounted to $5.3-billion, adding to a cash hoard that now stands at $16-billion. That liquidity has allowed the company to spend more than $2-billion on share buybacks this year, $600-million of which occurred in the last quarter.
Dell may not be running as well as it was in the PC heyday, and it doesn’t look as hot next to competitors such as Apple, but it is still a profitable company with a lot of cash. The question for investors is ‘why invest in it now?’
“Dell has a lot of locked-up potential in its long-term enterprise strategy,” says Roger Kay, president of Endpoint Technologies Associates Inc., a technology market intelligence firm based in Wayland, Mass. “It has an opportunity to be a real enterprise player, if Michael Dell is smart enough not to focus on the short term and to invest properly.”
The company embarked on the shift several years ago, and it might take Dell as long as a decade to build the new franchise. In the meantime, the shares are relatively cheap while the company is making money and buying back its stock, he says.
Eventually, Dell may approach IBM as a real competitor, but for now IBM is unique in the tech sector. It has a stable business, a huge portfolio of related products and services and it has the ability to operate well without a big personality at the forefront. These are the attributes that finally persuaded Mr. Buffett that Big Blue is a good buy.
“Buffett doesn’t really invest in sectors, he invests in companies,” Mr. Kay says.
Follow us on Twitter: