Financial Reference

Dell reported earnings yesterday afternoon and the stock promptly dropped 10% after hours. Obviously, investors did not like what they heard.

Dell reported earnings a penny shy of estimates and revenues that slightly beat forecast. With revenues higher and earnings lower, they obviously reported lower margins. Operating income, as a percent of revenue, declined quarter over quarter from 6.1% to 5.3%.

The cash conversion cycle, a measure of how quickly Dell is paid by their customers versus how quick they pay their suppliers dropped from 38 days to 35 days. In addition, management was not overly optimistic about the future, saying that they have seen some minor changes in purchasing by some financial firms, but overall, they have not seen a change in orders from the economic woes.

Despite all of these worrisome trends, the selling was overdone. As everyone knows, Dell has been pushing into the retail space. Selling through retail should reduce margins and hurt the cash conversion cycle. And management had a history of overpromising and stretching (sometimes illegally) to meet their guidance.

After the selling Dell had a market cap of $56 billion. They have $14.8 billion is cash and investments on their balance sheet. This leaves just over $40 billion in value attributable to the business. On the cash flow side, Dell reported free cash flow (after stripping out interest payments) of roughly $750-800 million last quarter. At this rate, Dell’s operations are selling for only 13 times cash flow.

This is extremely cheap given Dell’s huge return on capital. (Their return on capital has trended lower to 32%, in part due to a huge increase in cash on Dell’s balance sheet.)

Despite short term trends that may be negatively impacted by product mix, Dell is a huge value right now. Dell has ridiculous returns on capital and can be bought for only 13 times cash flow.

It’s a wonder that in any serious pursuit, someone could be happy that they were behind. It’s even more perplexing when the pursuit is the alpha-dominated investment industry. But I think Jonathon Clements is on to something.

In an article written today, I’m a Loser and I Couldn’t Be Happier, Clements discloses that he has lost a “boatload” in recent weeks he “couldn’t be happier.” First, I have to “B.S.” — you would be happier with more money. Even the most passionate value investor can feel sick to his stomach after the recent turmoil. That being said, Clements is right.

As I wrote in a recent article, the time to buy is when you feel a sickness in your stomach, when all of the news reflects a depressed outlook, when people start asking you whether they should stop investing in stock market altogether. In short, the time to buy is when your stomach tells you run and your brain is starting to agree.

The reason it is such a good time to buy right now is that all of the rampant pessimism decreases the price of assets, especially in sectors connected to the bad news. As Clements states, “This sort of market turmoil scrambles valuations and creates opportunities.”

When the market is ruled by emotion and short-term thinking, as it is currently, opportunities are created to buy great businesses at low multiples. While it is true that in the short-run, many of these opportunities will continue to be volatile, money can be made by taking advantage of other investors short term thinking.

I can see how Clements has convinced himself he is happy. Intellectually, we should all be happy if we are able to purchase more with less. But, it’s hard to imagine that he is actually smiling underneath.

I tend to be more concerned about day to day fluctuations in the market than Brian does. I can’t help but be happy when all of our stocks are up and a little upset as things go down.

Brian used to have all of our portfolio information on yahoo, so at the end of everyday there would be a green or red number at the bottom displaying our gains or losses for the day. Unfortunately it was much too easy to check everyday or several times a day how we were doing. Now, since retirement is still decades away, the day to day fluctuations really mean nothing at all. Seeing how this was affecting me, he removed much of the information, though I still know what stocks we own.

Obviously I can still figure out rough estimates for the day, if I wanted to put the time into estimating, but I rarely know from day to day the value of our net worth. I would say that it’s made me calmer about Brian’s investment strategies. And if I want to know what our net worth is, I can check a spreadsheet on his computer, or ask him.

The past month in the market has been rather tumultuous - the timing of which couldn’t have been worse for me. I’ve been placed on bedrest for approximately 10 weeks (3 weeks down, 7 more to go) so I have even more time to kill. I’ve been trying hard not to follow the markets too closely.

But it’s fair to say that money has beeen on my mind throughout this bedrest experience. I’m still waiting for my short term disability claim to be approved (or denied) and I’m attempting to work remotely 20 hours a week, which has been a challenge in and of itself.

In the end I just remind myself that there is a reason that Brian manages our investments, in that he has the interest and knowledge of the subject while I find it rather dull and that the short term really doesn’t matter..

“When there’s blood on the streets, buy property.” - Baron de Rothschild

Every major bank is being hit with concerns over the debt they hold. Yesterday, Morgan Stanley reported a $3.7 billion hit to their fourth quarter earnings. Previously, Citigroup announced a $8-11 billion hit to their fourth quarter, after taking a hit in the third quarter.

While the fallout has been much higher than I anticipated, the recent sell-off has given everyone a great opportunity to buy.

Let’s look at Citigroup, for example. The big worry here is that Citigrup will need to raise capital or lower its dividend to increase its capital ratios. So what? Citigroup has many assets it can sell at less than firesale prices and who cares if they lower the dividend? It shouldn’t materially affect the long-term value of the company.

Even though the write-downs sound huge, Citigroup usually earns $5-6 billion per quarter after taxes. The two announced write-downs, after taxes, should only be equal to about 3 quarters of earnings for Citigroup.

After Citigroup takes the charges in the fourth quarter, the ship should start to right itself. In fact, analysts expect Citigroup to earn approximately $4.40 a share next year. This means you can buy this company, a company with an average ROE above 15% for a forward P/E of 7.6 (based on the price this morning of $33.41).

Citigroup looks cheap to me.

Disclosure: I own Citigroup. As always, perform your own research before making investment decisions.

In the last post, I said that I would much rather mistime than misvalue. This reminded me of an article I read recently.

Michael Sivy writes an article every month for Money magazine in which he updates his recommended portfolio (the “Sivy 70″). Considering he only has to update his portfolio once a month and give a paragraph or two explanation, it could very well be one of the easiest jobs in the world.

The one hard part of the job is that he opens his picks up for criticism. One of his recent actions had to be based on psychological/technical reasons rather than fundamental analysis. In his September 12, 2007 post
he replaced Dell with HP.

Obviously, before his post HP was on a tear and Dell had been slumping for years. Just as obviously, Dell has been en fuego after the article. See chart.

The problem with this pick is that it wasn’t just a mistiming. He replaced Dell after a long period of underperformance. If anything, Dell’s fundamentals had only improved. But it can be hard to keep the faith if the stock price is stagnant. If Sivy would have stuck with his original analysis and not, presumably, been influenced by relative performance he could have seen which stock offered the more compelling value.

Disclosure: As I have disclosed earlier — actually just a week after Sivy replaced Dell with HP — I have an interest in Dell. See earlier post arguing that Dell was in fact cheap even though it had a high raw P/E ratio.