Random Thoughts

Minyanville - August 16th, 2006

I'll pose these questions for readers:

Let's say the scenario that I described in this article plays out, the Chinese economy slows down, its massive operational and financial leverages create deflationary pressure on the companies forcing them to lower prices in an attempt to stimulate sales growth, starting a price war which would in turn lead to even lower profitability, driving many companies into red. A sudden loss of profitability would lead the bad loans, which are estimated to be around $900 billion (40% of GDP), to become a real problem.

Let's say government decides to take a hands off approach and not take the Japanese route by creating a zombie economy and would let the market forces play out (I know I am stretching here). If (actually in my mind it is a question of when, not if) all that takes place, what would happen to:

1. The U.S. dollar reserves, would Chinese companies have to pull the money out of U.S. Treasuries? What would happen to the U.S. interest rates? Long term and short term?

2. What would happen to the Chinese/U.S. Exchange rate?

3. Would the Chinese exported deflation throughout the world be a net positive? Or we may see an Asian contagion spreading throughout the world?

We have nothing to fear but Google itself

Let's say written in the past, though Dell (DELL) appears to be cheap relative to its past valuations, I believe it is not cheap on an absolute basis, which is more important for range bound markets.If Dell decides to take a recommendation from Barron's and start opening new stores, it will be a kiss of death as it will give up on its last competitive advantage. Just take a look at Gateway (GTW).

I believe Microsoft (MSFT) is a much easier play on the computer sector. Its valuation is very attractive, 14x earnings (excluding cash that is going back to shareholders through stock buy backs and rising dividends). It also has a Google-will-take-over-the-world discount built into it, which I believe will dissapear a lot sooner than later.

Another stock that becoming more and more appealing through valuation (though not there yet) due to Google (GOOG) fears is Ebay (EBAY).

More on Dell, Intel, HP and AMD

Professor Gilmartin and I were exchanging thoughts on Dell's (DELL) valuations. Trying to figure out what is the appropriate buy valuation for the stock that would have an appropriate margin of safety.One thing I have found is that relative valuation (i.e. today's P/E vs. where it was in the past) is skewing many fundamental folks' view on Dell's attractiveness. But I believe it is very important to attempt to come up with the appropriate absolute valuation for the company first and only then look at the past valuations. If one does that, then today's P/E or P/CF may not appear to be as attractive. I am not in love with Dell (DELL) at today's price, falling in love with Hewlett-Packard (HPQ) looks like a mistake to me. Just scanning through Dell's conference call (albeit between the lines) it is fairly clear that Dell will not let HP prosper at Dell's expense.

Also, aside from offering customers "variety," I gather from reading the transcript that Advanced Micro Devices (AMD) is likely to be undercutting Intel (INTC) on price. Maybe that is their way to get into Dell's computers and get the scale needed to compete with Intel? But that is a risker strategy. Just compare Intel and AMD's operating margins.

Vitaliy N. Katsenelson, CFA This article is written for educational purposes only. It is not intended as a recommendation (or advice) to buy or sell securities. Author and/or his employer may have a position in the securities discussed in this article. Security positions may change at any time.