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What's Dogging Dell's Stock


Few investors would dispute the notion that Dell Inc. (DELL) is one of the great companies in tech. The world's largest computer maker's earnings jumped more than 25% last year, outpacing a nearly 19% rise in sales. It has a clear playbook to push into higher-margin products and new geographic markets. So why are Dell shares down 16% since the end of last year, while those of rival Hewlett-Packard Co. (HPQ) have soared more than 27%?

HP is simply beating Dell hands down in managing Wall Street's expectations. HP was long one of tech's most mediocre performers -- famous for big earnings disappointments and unfulfilled ambitions. But the stock lost its "Carly discount" after the divisive Carleton S. Fiorina was shown the door in April, and the new chief executive, Mark Hurd, began doing the right things. He has attacked bloated costs and brought in new management blood. Analysts expect the no-nonsense Hurd, known for underpromising and overdelivering on results, to boost already-rising earnings through nuts-and-bolts operating improvements such as more disciplined pricing. Says Merrill Lynch & Co. (MER) analyst Richard Farmer, "We think Wall Street is still underestimating HP's earnings power."

By contrast, Dell is becoming a victim of its own success. On Aug. 11 the company announced a second-quarter sales increase of 14.7%, far outpacing HP's 10% rise. The Round Rock (Tex.)-based Dell said it cut prices too much and didn't sell as much as it hoped to the federal government. Trouble is, the sales number was below its own earlier forecast of a 16% to 18% increase. Worse yet, Dell also ratcheted down its revenue projections for the current quarter ending in October. Dell's stock immediately tanked 7.4%. Some analysts are questioning whether Dell stock still deserves its longstanding premium rating. On Aug. 12, high-profile Goldman Sachs & Co. analyst Laura Conigliaro downgraded Dell to "market perform" from "outperform" because of the lower estimate for future sales growth.

Until this year, Dell gave specific guidance for sales and earnings. But in the first quarter, the company began giving a range instead. Dell spokesman Jess Blackburn explains that as the company gets bigger and more global, "being able to predict a precise outcome for a quarter does become more challenging." Some investors aren't happy with the change, especially when Dell misses the target range. "Management has been leading investors in somewhat of a whipsaw," says Tony Ursillo, an analyst at mutual fund group Loomis, Sayles & Co., which owns about 2.8 million Dell shares. "Had Dell come out at the beginning of the year and said it would achieve a 15% growth rate, the stock wouldn't have been so volatile."

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Aside from the problem of Dell missing its own expectations, analysts figure the company's revenue growth is unlikely to get back to the 17% to 18% pace it was posting a year ago. That's because about 79% of Dell's $49 billion in sales last year came from desktops and notebook computers, both categories in which prices are falling. While analysts generally applaud Dell's expansion into higher-margin products such as music players and flat-screen TVs, "its entry into consumer electronics is seen as evidence that the core businesses are maturing and that it doesn't deserve a premium stock value," says Richard Chu, analyst at SG Cowen & Co. (SCGLY).

That leaves Dell investors still scratching their heads, wondering whether there's another revenue shortfall in the cards. Chu says Dell's troubles this year "create questions not about whether this is a bad team, but whether a good team is missing because the game is getting tougher." If that's happening, investors may just have to lower their expectations about Dell's earnings -- and its stock.

By Louise Lee with Peter Burrows in San Mateo, Calif.


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