How Dell stocks up vs. Gateway

When Dell Computer (DELL) reported its second quarter today its net profits doubled and its revenues grew by leaps and bounds.

But while Dell's continued top-line growth was positive, the question remains whether it remains a good investment--especially relative to competitor Gateway 2000 (GTW)--with its stock trading at such a premium.

Both companies' stocks are trading near their all-time highs: Dell is near 84 a share, while Gateway is hovering around 40.

The price-to-earnings ratio, a useful barometer for the value of stocks, quantifies the relationship between a company's annual earnings per share and its current stock price. Dell, based on its earnings reported today, has a P/E ratio of 41.9. Gateway is at 23, based on its most recent results.

"The stock market puts a price on future earnings, and right now Gateway is cheaper," said Mark Specker, an analyst at Soundview Financial. "But that doesn't mean it's a better buy."

Of course the fundamentals, such as revenues and net income, bear careful consideration.

Dell and Gateway, which share a business model, sell computers directly to users, eliminating the middleman.

Although they are trying to edge onto each other's turf, the companies largely target different markets. Dell is focused on the corporate market, while Gateway has a hold on the consumer market.

Gateway is seeing a slower growth rate in earnings.

As it generates the majority of its revenue from consumers, Gateway is susceptible to the consumer spending cycle. The fourth quarter, coupled with holiday spending, produces the year's strongest results.

In July, the company, which has launched a number of recent initiatives to entice the corporate market, announced a 10 percent increase in second-quarter profits. Sales of its Gateway Solo line of portable PCs hit historic highs for the quarter. Gateway posted net profits of $56.5 million, or 36 cents a share, for the quarter ending June 30, compared with $51.4 million, or 33 cents a share, a year ago. Revenues, meanwhile, rose to $1.39 billion, up 23 percent from a year ago.

But Dell's growth rates are greater than Gateway's. For example, the company today reported a 108 percent jump in earnings to $214 million, compared with $103 million last year. And its revenues climbed 67 percent to $2.81 billion, up from $1.69 billion over the same quarter last year.

Analysts, however, say to look beyond earnings, revenue growth, and EPS (earnings per share).

The five-year historical earnings-per-share growth trend for Dell was 62 percent, while Gateway's historical growth was 27 percent, according to First Call.

But going forward, Dell's EPS growth is projected to decrease to 24 percent and Gateway is projected to slow to 22 percent, as the market matures and becomes somewhat saturated.

With earnings projected to settled back in the 20 percent range, the long-term investor may see Gateway a good investment because it requires investors to spend less to buy into comparable future growth. Short-term investors, meanwhile, may find Dell a better buy because it's currently on a fast track, analysts said.

"Gateway is developing brand franchise, so it's not growing as fast, but it's high-quality growth. In the long term they are going to be in pretty good shape. We are entering an era of consolidation, and branding will help," said Louis Mazzucchelli, an analyst with Gerard Klauer Mattisoni.

Analysts say Dell's stock price is so much higher partially due to physics: Things in motion continue in motion. That momentum has made Dell a more expensive stock compared to other companies in the computer group.