Investors might be concerned that it's too late to buy Dell (DELL -17.87%) stock after its big gains in recent months. While the stock has nearly doubled so far in 2024, the company may be in the early stages of an industry boom period, and now's a great time to analyze this company's opportunities and valuation to figure out if it's still a good time to buy.
What's driving Dell stock higher?
Dell stock jumped 8% in January, followed by a 14% gain in February. It kept that momentum going in March with a 21% gain, and notched a 9% gain in April. The stock is up 95% year to date. Those are big gains in a short time frame for an established, mature company. Many investors will take that as a sign that it's too late to get on board, and that any upside potential is already fully reflected in share price. Alternatively, this could signal the early stages of a major turnaround for a stock that was trading at an unnecessary discount.
As has been the case with other tech stocks, artificial intelligence (AI) is driving the hype around Dell. The company is probably best known for producing personal computers for consumers, but it also has a large server business. AI applications require significant computing power, and Dell is hopeful that tech companies will need to maintain significant on-premises server resources. The company is in a prime position to capitalize as a leader of the server market, just ahead of noteworthy peers including Hewlett Packard Enterprise, Super Micro Computer, and Lenovo.
Image source: Getty Images.
The personal computer market is highly competitive and saturated, so it's not particularly exciting over the long term to investors. Even worse, it's a cyclical business that's experiencing lean times right now. That is clearly showing up in Dell's financial results. It reported 11% revenue contraction and 10% lower operating income relative to the prior year in its most recent quarter. However, investors were focused on its outlook. The company is forecasting a return to growth this year, thanks to AI server demand and a recovering consumer segment.
In its most recent quarter -- reported on Feb. 29 -- Dell did beat Wall Street's estimates thanks to exceptionally strong demand in its storage segment. Its AI servers backlog nearly doubled during the quarter, suggesting that sales are about to take off in the next few quarters. Analysts now expect 5% to 6% revenue growth in each of the next two years, with earnings growth outpacing the top line. The revised forecasts represent nearly 10% increases from earlier this year.
Wall Street saw this as a shrinking business just a few months ago, but that's quickly been replaced with a more optimistic outlook.
What's happened to valuation and dividend yield?
Dell's gains were primarily driven by valuation expansion rather than short-term profit forecasts. The stock's forward price-to-earnings ratio, price-to-free-cash-flow ratio, and enterprise-value-to-EBITDA ratio have all risen dramatically this year. These ratios compare the stock's price to different profitability measures, using estimates of the coming year, so potential buyers now have to pay a larger premium relative to the underlying company's financial returns.
As the stock's price has risen, the stock's dividend yield has also dropped, even as the company increased the dividend 20%. The stock currently has a forward yield of about 1%. This means that the same amount invested would only generate half as much dividend income relative to the start of the year. That's an important consideration for income investors and retirees who rely on cash flow from dividend stocks.
DELL Dividend Yield data by YCharts
Is the stock a buy now?
Shrewd investors don't succumb to the "fear of missing out" (FOMO), so they wouldn't buy shares just because they are rising. For Dell, I think investors need to temper their expectations. This isn't a company that's going to deliver 20% revenue growth, so you wouldn't expect the same potential upside that you see with high-flying software stocks.
However, there's a good chance that Dell's valuation doesn't fully reflect the company's emerging potential, even after the recent increases. In the quarter ended Feb. 2, storage revenue represented nearly one-quarter of total sales, while consumer revenue was under 10% of the total. A cyclical rebound in consumer products that coincides with surging AI server demand could yield impressive growth along with margin expansion.
Dell's forward P/E and price-to-free-cash-flow ratios are under 20, which would look cheap if the company is able to approach a double-digit growth rate. As it stands, the stock trades at a more attractive PEG ratio than its closest rivals. The PEG ratio factors in a company's earnings growth rate.
DELL PEG Ratio (Forward) data by YCharts
Dell's relatively modest valuation shifts the risk-reward balance in favor of buyers. This provides some protection to the downside if the investment narrative falls apart, and it also creates more room for valuation expansion if the company winds up performing even better than expected. Even better, the company is actively repurchasing shares, which helps to increase earnings per share.
This is one of the few value stocks that provide meaningful exposure to AI-driven trends. The stock is worth a look for income investors or anyone seeking a bargain that the market might be overlooking.
