Dell and Other Stocks with Hefty Expected Returns
Plus several other stocks that recently hit 5 stars.
Plus several other stocks that recently hit 5 stars.
Following is a sampling of stocks that recently jumped to 5 stars. By way of background, we award a stock 5 stars when it trades at a suitably large discount--i.e., a margin of safety--to our fair value estimate. Thus, when a stock hits 5-star territory, we consider it an especially compelling value.
To get a complete tally of stocks that have recently jumped to 5 stars--as well as our full list of 5-star stocks--including our consider buying and selling prices, risk ratings, and moat ratings--simply take Morningstar Premium Membership for a test spin. Click here to sign up for a free trial.
Dell
Moat: Wide | Risk: Average | Price/Fair Value Ratio*: 0.74 | Three-Year Expected Annual Return*: 20.7%
What It Does: Dell produces and sells a wide range of computer systems and services worldwide. The company sells desktop and notebook computers (34% and 27% of sales, respectively), software and other peripheral equipment (16% of sales), servers (10% of sales), storage (4% of sales), and enhanced services (9% of sales) to commercial customers and consumers.
What Gives It an Edge: According to Morningstar analyst Rick Hanna, world-class supply-chain efficiencies provide Dell with a wide economic moat. The company employs a streamlined build-to-order production process, from customer order to shipment. Its efficient process, which now includes indirect partners (retailers and value-added resellers), offers several advantages: a faster response to changes in product demand; the ability to take advantage of declining component costs sooner; and lower inventory carrying costs. The company's scale also enables it to negotiate favorable contract terms with its suppliers, such as longer payment terms and lower prices. In fact, the firm maintains the best working-capital management in the industry, enabling it to collect money from its customers before it pays its suppliers and generate excess returns on capital.
What the Risks Are: Hanna's biggest concern for Dell is its ability to manage conflicts between its direct and indirect salesforces for small-business customers. Additionally, the company will face ongoing competition in hardware sales. Lastly, even though Dell concluded its internal investigation into its accounting for deferred revenue and warranty liabilities, the Securities and Exchange Commission is still conducting its own independent investigation.
What the Market Is Missing: The market is expecting Dell to continue to struggle, particularly as it moves into indirect channels, and to face ongoing margin pressures. Hanna agrees in part with the consensus opinion, but he sees signs of life where others don't. First, he believes the company will continue its strong growth in servers and storage, thanks to its low-cost advantage. In fact, it boasted faster revenue growth than any other competitor for both segments in 2007. Second, the company is increasingly selling more than just hardware. Sales from software and services now make up about 25% of total revenue, up from less than 20% just two years ago. Hanna expects Dell to continue to increase these higher-margin services faster than core hardware sales. The company has also made significant acquisitions in the past year to bolster its services offerings.
Williams-Sonoma
Moat: Narrow | Risk: Average | Price/Fair Value Ratio*: 0.67 | Three-Year Expected Annual Return*: 25.5%
What It Does: Williams-Sonoma (WSM) offers products for the home through retail stores, catalogs, and the Internet. Its offerings include bath and storage products, bedding, cookware, furniture, and tableware. The company's retail concepts include Williams-Sonoma, Pottery Barn, Pottery Barn Kids, PBteen, West Elm, and Williams-Sonoma Home. The company sells merchandise through its seven catalogs, six e-commerce Web sites, and approximately 580 stores located throughout the United States and Canada.
What Gives It an Edge: Over the years, Williams-Sonoma has developed into much more than a typical home furnishings retailer--it has become a lifestyle brand. The company serves a loyal middle- to upper-income customer base through its multichannel and multibrand retail business. By operating through different channels (catalog, Internet, and retail stores), the company is able to capitalize on its broad customer reach and gather valuable consumer data. While Williams-Sonoma's direct-to-customer channels provide the company with a nationwide presence, Morningstar analyst John Gabriel thinks the most important benefits of the firm's multichannel strategy lie in its planning and marketing capabilities. With established catalog and Internet retail channels, Williams-Sonoma has built a platform to test new concepts and gauge customer response. In addition, the valuable customer information the company acquires through its direct-to-customer businesses helps with cross-promotional activities and enables it to refine its merchandising and marketing strategies.
What the Risks Are: Competition in the home furnishings industry is intense and poses a significant threat. Williams-Sonoma also faces fashion risk, given that merchandising missteps can be detrimental to the firm's financial performance. Additionally, with so many different retail concepts, the company risks diminishing its brand identity with too much customer overlap and a lack of product differentiation between concepts. Prolonged weakness in the U.S. housing market or reduced consumer spending would also negatively affect sales growth.
What the Market Is Missing: Deterioration in the U.S. housing market has taken its toll on the entire home furnishings industry, and Williams-Sonoma's Pottery Barn concept, which makes up almost half of the company's total revenues, is no exception. Gabriel also attributes some of the Pottery Barn's recent woes to merchandising missteps made by the company. However, the company, in Gabriel's opinion, was able to stop the bleeding, and its customer base is less affected by economic pressures. Although he anticipates overall sales will moderate and profitability will be pressured in the near term, Gabriel is optimistic about Pottery Barn's recovery, due to its quick reactions to fixing problems and a history of success in rolling out new concepts.
Other New 5-Star Stocks
Amgen (AMGN)
Jack In The Box
Performance Food Group Company
* Price/fair value ratios and expected returns calculated using fair value estimates, closing prices, and cost of equity estimates as of Friday, Dec. 14, 2007.
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