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Give Dell a Chance

The company had some bright spots in its weak fourth quarter.

SAN FRANCISCO -- Investors have waited a year for a clear sign that

Dell's

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comeback has begun in earnest.

By

falling short of Wall Street estimates Thursday, Dell sent the opposite signal, and its stock took a hit.

But the PC maker's rehabilitation may be going better than it appears.

For all the weak spots in Dell's fourth-quarter report, there are several important milestones worth noting.

For one thing, Dell's transformation from being a direct seller of PCs to one with a more traditional retail approach is off to a promising start.

U.S. consumer sales -- which declined 6% year-over-year in the third quarter -- posted a 12% increase from the year-ago period in the fourth quarter. Notebook sales grew 24% year over year to $4.8 billion, the strongest showing in more than a year, and an important achievement for Dell which previously seemed to be missing out on the PC market's fastest-growing segment.

Despite having never had a presence in stores like

WalMart

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,

Best Buy

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and

Staples

(SPLS)

, and suffering a bruising to its brand over the past year (remember that battery recall), Dell appears to be enjoying decent demand.

Of course, Dell still needs to adjust its business model to the realities of the retail world. According to Citigroup's Richard Gardner, Dell's U.S. consumer operating margin was -2.4% in the fourth quarter, compared with -1.4% in the third quarter.

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"We believe this is largely a function of aggressive pricing, particularly in the retail channel, but more importantly, a supply chain that is in need of an overhaul," wrote Gardner in a note to investors Friday.

Citigroup has provided investment and non-investment banking services to Dell in the past 12 months, makes a market in Dell shares and a Citigroup officer is a director at Dell.

Dell's shares were down 3.9%, or 82 cents, at $20.05 in midday trading Friday.

"They are making progress. It's just from an investment standpoint, it's slower than what investors would like to see," says Atlantic Trust SteinRoe's Chuck Jones, who has positions in

Hewlett-Packard

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and

Apple

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, but not Dell.

Dell is also growing out of its provinciality, making strides in expanding outside the U.S. and into emerging markets, where much of the PC market's growth is expected to come from in the coming years.

A year ago, Dell said that international unit shipments exceeded U.S. shipments for the first time in company history, with revenue from outside the U.S. comprising 46% of the company's total sales. In its recently ended fourth quarter, non-U.S. sales accounted for 49% of company revenue.

In the so-called BRIC countries (Brazil, Russia, India and China), Dell said revenue increased 36%, with unit shipments up 50%. And sales in the Asia-Pacific region grew 28%.

The flip-side of this progress is that Dell's bread-and-butter -- the U.S. corporate business -- appears to have slowed in the fourth quarter.

Friedman, Billings, Ramsey analyst Clay Sumner ascribed the softness to a temporary transition in the available server products during the quarter.

"We also think H-P gained corporate PC share against Dell in the quarter, while ceding some of the less profitable consumer business that Dell is so focused on building," Sumner wrote in a note to investors Friday.

Friedman, Billings, Ramsey makes a market in Dell shares.

Sumner said Dell's defense of its U.S. corporate business against H-P will be a key area to watch in the coming quarters. But he raised his rating on Dell to outperform on Friday, citing the potential for Dell to cut costs and increase its profit margins going forward.

Dell's cost structure remains one of its biggest opportunities for improvement, as well as one of the Street's biggest causes of concern. The company's increased operating expenses in the fourth-quarter did not sit well with investors, particularly given that Dell fell short of analyst sales and earnings expectations.

Dell's management faces the challenge of cutting expenses while attempting to position the company to grow in new areas like retail, emerging markets and services.

With so many challenges and opportunities hanging over Dell, don't expect the story of the company's comeback to be told in one quarter.