Why PC Stocks Are No Longer a Profit Area

by George Leong, B. Comm.

Dell Inc. (NASDAQ/DELL), the world’s largest computer maker, used to be the toast of Wall Street. Investors bid the stock price up from $0.10 in August 1988 to nearly $60.00 in early 2000, before the technology market imploded and crushed growth stocks. Dell is currently trading at around $11.00, over 50% off its 52-week high. Yet, even with the decline, I question Dell’s potential as a growth stock in what has become a low-margin business, where volume drives results.

The results from rival Hewlett-Packard Company (NYSE/HPQ) paint a somewhat dismal picture for those companies in the personal computer (PC) and accessories market. HP reported a weak first quarter and said that revenues in the second quarter will be flat to down two percent due to continued global slowing.

Dell and the other PC makers will continue to struggle. The former company is no longer viewed as a growth stock, but is valued as a commodity stock trading at 9.16X its estimated fiscal 2011 (ended January) EPS of $1.22 per diluted share. Earnings growth has slowed in this low-margin business. Over the next five years, earnings are expected to rise only 11.63% annually, which is clearly not growth metrics. If you are looking at Dell for strong price appreciation potential, look elsewhere. In fact, companies like International Business Machines Corporation (NYSE/IBM) and Hewlett-Packard Company (NYSE/HPQ) have similar valuation, but they pay out dividends.

For Dell, revenue and earnings growth has slowed considerably due to intense competition and the fact that computers are now commodity stocks. For fiscal 2010, ending in January 2010, revenues are predicted by Wall Street to contract 15.3% and then rebound 2.6% in fiscal 2011. These are not growth numbers, but then there is a global recession.

The reality is that the easy profits have been made on Dell and it is time to move on if you have not already done so. Dell is not a buy and hold stock, but is a trading stock at this time.

Increased competitive pressure for world market share from other key players is impacting Dell. For instance, China-based Lenovo, which acquired the “ThinkPad” business from IBM a few years ago, is currently threatening Dell’s stranglehold on the world market share. Dell is trying to expand its foothold in the Chinese market, but this will not be easy due to the highly competitive market there.

The fact is that the computer business is a commodity market where margins, which used to be higher, are now squeezed. This is the trend and I do not expect it to change as competition heats up going forward. Where in the past, the PC market may have been considered a growth area; you can no longer say that. The market is in the mature stage of the product cycle. Price competition for market share will only rise. Investors looking for growth should bypass PC makers and look for companies that are innovators in technology and where the product is in its early stage. Look for opportunities in networking, software, and non-PC hardware.