JDSU Shareholders, Remember The Year 2000?

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

History is an expensive teacher, and while it's not year 2000, JDS Uniphase (NASDAQ: JDSU) shareholders are repeating some of the same mistakes. Back in February 2000, JDS stock rocketed up to over $1,000 a share on expectations for huge growth. By the end of the year, reality started to set in and the stock was at $333. Six months later, the stock was at $100, and today, $14.16. The point is just because the market has high expectations doesn't mean the company can deliver on these expectations.

The reason this applies to JDS today is the company is expected to grow at 12.50%. The same company however, sports a forward P/E of 22.48. This gives JDS a forward PEG of 1.80. For point of comparison, Cisco (NASDAQ: CSCO) the 800 pound gorilla of the networking field, sells for a forward P/E of 10.87 with an expected growth rate of 8.69%. This gives Cisco a forward PEG of 1.25. Another competitor, Alcatel-Lucent (NYSE: ALU) sells for a forward P/E of 8.54 with expected growth of 8.33%. This gives Alcatel-Lucent a forward PEG of 1.03. It appears that JDS sells for a premium of 44% and 74.76% to two of its well know competitors.

Knowing that earnings don't existing in a vacuum, we need to also compare JDS's free cash flow generation. JDS has generated about $0.037 of free cash flow per $1 of assets in the last year. Cisco generated about $0.11 of free cash flow per $1 of assets in the same timeframe. Alcatel-Lucent generated about $0.028 of free cash flow per $1 of assets. Looking at these results, JDS shareholders should be concerned that their company generated only a little more free cash flow than Alcatel-Lucent. Given that Alcatel-Lucent nearly vanished under their long term debt load, JDS in theory should be doing much better.

The one factor that could change the investment thesis with JDS is the fact that the company has been beating earnings on a fairly consistent basis. In the last four quarters, JDS has beaten estimates by an average of 24.62%. Even if JDS continues this streak of beating estimates, the company might earn $0.79 this year. With earnings of $0.79 the stock still would sell at 17.92. With a growth rate of 12.50% this would still put the PEG at 1.43. This is a pretty big assumption, and even if it occurs, JDS would still be overvalued relative to their competition.

Looking for a fair valuation on JDS, let's see what the stock would sell for if we use a comparative PEG approach. If JDS meets estimates, the stock should sell for a PEG of between ALU and CSCO. With the mid-point being 1.14, the stock could sell for 14 times earnings. At 14 times 2012 full year earnings, the stock would sell for $8.82. If we compare cash flow, JDS should sell for something closer to ALU because of the similar cash flow. Even with free cash flow coming in at 32% higher than ALU, a similar premium in PEG would make a forward PEG of 1.35 for JDS. A second approach is using expected earnings of $0.63 a P/E of about 17, the stock would sell for $10.71. No matter how you run the numbers, it looks like JDS could be overvalued by between 24.3% and 37.7%. If you are looking to buy a networker today, it's hard to argue with buying Cisco. The company sells for a more reasonable value, generates almost 4 times the cash flow of JDS, and pays a growing dividend. Sorry, JDSU gets a red thumbs-down on CAPSCall for now. The expected growth just doesn't seem to justify the current stock price, just like in 2000.

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