# The Value of DELL using the EBIT Multiple Valuation Method

Written by

Jae Jun

Let me go through a EBIT multiple valuation method using DELL. The link to the free online calculator is at the end of the article.

PE multiples are thrown around a lot when talking about stocks, but there is a much better way to value stocks using multiples and that is to use  EBIT multiples.

Don’t get shocked. Just because I’m a value investor, it doesn’t mean I do not look at multiples. I like to concentrate on value based metrics such as P/FCF, which is a variation of P/E, and even EV/EBITDA, but the more tools I have and understand how and when to use it, it only helps me as an investor.

Seeing that most people incorrectly use multiple valuation methods, I will show you how to do it the proper way.

#### How People Perform Multiples Valuation

The All Too Common Way

You may have heard this sort of analysis before.

DELL is trading at a PE of  10.6x with a Forward PE of 8.7x. It’s competitors are trading between 9x to 14x.

If DELL corrects their problems, it should trade at similar multiples to its competitors.

Therefore DELL is worth \$18.

Problems Doing it This Way

Right away there are some fundamental flaws.

I understand the importance of keeping things simple, but not so simple that it affects the whole underlying principle.

PE is a broad metric which can vary greatly depending on adjustments to the income statement such as:

• A goodwill charge can reduce earnings drastically although it doesn’t affect the business operation
• Income from discontinued operations can inflate PE

#### EBIT Multiple Valuation is The Better Way

You start with a normalized revenue estimate, enter a conservative, normal and aggressive operating margin to get the EBIT.

Then decide what multiplier you want against EBIT, add cash, subtract debt to get a total equity value.

It is simple and it doesn’t remove everything just for the sake of keeping it simple.

What’s more, if you are looking at a company with several subsidiaries, or operating segments that do vastly different things, you can apply the EBIT method for each segment and then add it up to get a sum of parts valuation.

#### Valuing DELL with EBIT Multiples

Let’s jump straight into the numbers and see how this works.

Numbers and assumptions I am using for a normalized case:

• Over the past 5-6 years, I normalized the revenue to be \$59b
• A normalized operating margin of 5.3% for a “normal” case
• A fair value EBIT multiple of 8x
• Add cash and subtract debt

See the image below to see how these assumptions are used to perform the EBIT valuation.

Dell – EBIT multiple valuation method

(The numbers for cash and debt came from the stock analyzer spreadsheet and verified against the latest 10-K)

DELL makes for an interesting case study because there are several big investors coming up with their own valuation targets which we can reference.

• Michael Dell wants to buy out DELL at \$13.65
• Carl Icahn has come out and said that he wants DELL to issue a \$9 special dividend because he values it at \$22.81
• Jim Chanos has revealed that he is short DELL going into the deal citing issues with the balance sheet and cash flow. (In other words, he doesn’t think it was worth \$13.65)

Although Jim Chanos has not revealed his target price, it will likely be closer to \$10 which is the lower end of the range.

Michael Dell is hovering over the normalized case to get a slightly cheaper deal than the fair value.

Carl Icahn is the optimistic and aggressive investor.

Question now becomes who is right based on the business model? Too early to say at the moment.

### Summary of the EBIT Multiple Valuation Method

As you can see, the EBIT valuation gives you a much better picture of the company and helps you take a step-by-step approach to valuing companies.

Something that a simple multiples or rule of thumb method does not allow you to do.

#### Please Share if You Find this Useful

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• Jon

Jae, I’m a new follower and in the process of reading Graham’s book, please so excuse my ignorance. My question is how do you do you determine your valuation multiple? Is there a range that is generally used in most cases?

• Ben

I think there may be in issue with the debt figure used in the valuation. It is my understanding that DELL consolidates debt issued to finance customer receivables so something should be done to account for that. Either remove the debt from the calculation or keep the debt and add back the receivables that were financed. This would be similar to how Southeastern Asset Mgmt treated Dell Financial Services in their valuation.

• http://www.oldschoolvalue.com/ Old School Value

I hate to say this since I wrote it but the “rule of thumb” is an EBIT between 6-10″. That is a large range, but it’s a start. This type of valuation is a relative valuation so if you can find a really close competitor, look at what multiple they are trading at. Then see if it makes sense to apply it to the company you are interested in.