Is EMC a Good Stock to Buy?

Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Data storage, infrastructure, and security company EMC (NYSE: EMC) has been left out of the stock market’s rise year to date, with its current stock price at about the same levels as the beginning of 2013 while the S&P 500 has risen about 15%.

This is, in part, due to higher costs in the first quarter of 2013, which caused pre-tax income to be essentially flat versus a year earlier after adding back restructuring and acquisition related items, even as the company’s revenue grew 6%.

EMC generated $1.7 billion in cash flow from operations during the quarter; the primary use of this case was to repurchase both its own shares and those of its subsidiary VMware (NYSE: VMW) (a portion of VMware’s stock trades separately in the market).

A closer look at EMC

Wall Street analysts expect EMC to earn $1.86 for 2013, which would imply a current year P/E multiple of 13. We saw in the company’s most recent 10-Q that the business did not appear particularly strong, but if EMC continues to buy back shares with its cash, that would reduce share count. We’d still prefer if the company was growing its earnings rather than just using repurchases to grow EPS, however.

The sell-side doesn’t seem to be expecting much of an increase in net income, with their forecasts only showing small improvements in earnings per share. As a result, we wouldn’t consider EMC a value stock right now just because of the stagnant performance -- if further results convince us that profits themselves might rise, then any reduction in share count could leverage that earnings growth nicely.

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According to our database, Tiger Cub Lee Ainslie’s Maverick Capital owned close to 11 million shares of EMC as of the end of March (find Ainslie's favorite stocks). Renaissance Technologies, whose founder Jim Simons is now a billionaire, initiated a position of 7.9 million shares (check out Renaissance's stock picks).

Comparing EMC to its peers

VMware has been growing its revenue at a slightly higher rate than EMC, going by its own quarterly report, though again, even after add-backs, we see little change in pre-tax income. Markets are valuing the stock at a premium to its parent; for example, the current-year P/E here is 22. With business conditions not being much different at VMware, we’d avoid it. We’d also note that 12% of the float is held short -- market players may be pair trading EMC against VMware.

We can also compare EMC to peers such as NetApp (NASDAQ: NTAP), Oracle, and Cisco. NetApp and Cisco trade at 12 to 13 times forward earnings estimates, roughly matching EMC’s valuation on that basis. These figures imply that analysts are looking for low earnings growth at Cisco but significant improvements on NetApp’s bottom line: that stock is valued at over 25 times its trailing earnings.

NetApp’s fiscal year ended in April, and in the fourth quarter, there was little change in either revenue or earnings compared to the same period in the previous fiscal year. Cisco’s business has been doing better, with net income up 15% in its last quarterly report compared to a year ago, and we’d be interested in taking a closer look at the company.

Oracle features trailing and forward P/Es of 14 and 10, respectively, so little growth is required in order to make it a good value. We’d note that while earnings have been up going by recent reports, there has been little change in revenue, and so we’d be concerned as to how sustainable its earnings growth might be.

Conclusion

Out of these three peers, Cisco seems to be the most intriguing prospect from a value perspective. As for EMC (and VMware to some degree, though as we’ve mentioned we don’t like its high earnings multiple on current year forecasted earnings) it is good that there is a strong buyback program but even if the company hits its earnings targets for this year the valuation will still be high enough that we will want to see growth in net income, not just EPS.

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This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool recommends Cisco Systems and VMware. The Motley Fool owns shares of EMC, Oracle., and VMware. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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