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There are two pieces of big news this week in the equity world – Apple stock has dropped back below $500 per share (from its high of over $700 per share not long ago) and Dell is considering being taken private by a private equity group and its stock is up 15% in the past two days and 40% in two months.

I won’t comment on Apple in this blog post, I’ll save that for another time, but I did want to discuss Dell.

Many of you know that we have been accumulating Dell between $8.99 per share and $12.70 per share, starting last May when the stock dropped by a third. I discussed Dell in this post about Facebook’s valuation [ Value Matters ] comparing the valuations of several “old” tech companies we had started to buy compared to the valuation for Facebook.

What we are seeing today with Dell is a recognition that they have a strong business with very good cash flow that has transformed itself from a primarily desktop PC maker to a primarily IT service company much like Accenture and IBM.

Accenture trades at 19 times earnings because it does not have the hardware business, just the consulting business. IBM trades at 13 times earnings because it does have the hardware business. Dell however trades at 8 times earnings.

The private equity firms have recognized what we saw starting last May – that this is a severely under-valued company based upon the successful transition of its business to a more relevant model. Hat tip to Charlie, who you read periodically here on the blog, for finding this company for us to add to client portfolios.

If we look at Dell’s projected 2013 earnings per share of $1.71 and say that it should be trading closer to IBM’s valuation (we can use 11.5 instead of 13 just to be conservative), this gives us a projected value per share for Dell of $19.65.

When you compare this to normalized valuation to our average cost basis during the accumulation period of $10.18, this gives us a potential upside for this particular company of 93%.

Will the private equity companies take it private at $19.65? Absolutely not. They are in it to make a killing, not to reward those of us that have recognized the potential in this company. However, Michael Dell as the largest shareholder will not sell it to them at fire sale prices, so we certainly have some nice upside yet to realize over and above the 23% unrealized profit we currently see based upon the current $12.56 price per share for Dell over our average cost per share.

Is it a done deal? Definitely not. This will be a huge private equity deal and the talk is that multiple companies will have to partner on it to get it done. That will be quite a feat and require a significant amount of debt. The good news is that Dell has more than enough cash flow to service the debt that the PE firms would need to buy out the existing shareholders.

As we move forward in our slow-growth world, three types of equity investing will be successful. All three have their pluses and minuses, but we employ all three in the management of our portfolios:

> Deep Value: the Dell situation is an example of a deep value investment where the market was not recognizing the worth of a strong company – these are tough to find, but when you do, you can hit a home run in terms of return as long as you are patient. Our holding period for these companies is only as long as it takes for the market to realize their true value.

> Core Holdings: these are companies in mature businesses that continue to growth their book value and their capital, pay consistent and growing dividends, have strong balance sheets that can weather swings in the economy, and significant cash flow to pay the dividends and add to capital. The returns on these companies tend to be more steady and are a combination of current income from dividends and capital growth from increasing their book value. Valuations for these companies in terms of P/E tend to be a bit less, in general, than the broader market. Our holding period for these companies tend to be longer than for the other two types and can last as long as the company continues to perform as described above.

> Earnings Growth: these are companies that are in growing segments of the economy who have the ability to increase their sales, market share and earnings per share faster than the broader market. The ideal investment candidates have the advantage that the segments of the economy they are in have some macroeconomic catalyst that pushes their business forward even in tough economic times. The returns from these companies tend to be higher, but the volatility is also higher and can provide wide price swings in short time frames. Valuations for these companies in terms of P/E tend to be above the broader market, but we also look at the PEG ratio to tell us whether the P/E is reasonable in terms of their estimated growth. Our holding period is based upon the company’s ability to maintain the competitive advantage that allows it to grow faster than the broader market.

Apple was one of the holdings that we owned as part of the Earnings Growth investment type. In a coming post, we will discuss whether Apple can continue to be an Earnings Growth holding or whether it is at the point that it should transition to a Core Holding based upon their business model and their position vis-a-vis their competition.

For now though, we will leave you some immortal words of the Dell Dude from their heyday as a PC maker:

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