Buy Cisco, Stay Far Away From Nokia
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
During the past six months, Nokia (NYSE: NOK) has been an actively-traded junk stock. It has lost nearly half of its value while being 57% more volatile than the broader market. What makes it a bad communications equipment firm? And what makes a good communications equipment firm? To set the contrast, I consider overvalued Nokia against undervalued Cisco (NASDAQ: CSCO).
Cisco trades at a respective 13.1x and 9.4x past and forward earnings with a dividend yield of 2.9%. It has 26% more volatility than the broader market but is worth the risk. The company's historical 5-year average PE multiple is 17.5x, but it makes little sense for the firm to trade below this amount as earnings have beaten expectations in all of the last 5 quarters by an average of 8.3% - excellent.
In terms of free cash flow trends, however, there has been a quick turnaround. FCF for the TTM ending April 30, 2012 was $10.2 billion versus $9.2 billion in 2011 and $8 billion in 2010. I calculate that the stock should be worth $28.28 in my DCF model.
My model forecasts 8.7% sales growth, consistent operating projections, a 10% discount rate, and a 2.5% long-term growth rate. Even a 1% perpetual growth rate and a 13% discount rate would make the stock slightly undervalued under these assumptions. I thus strongly encourage buying shares as multiples elevate from rising demand for smartphone innovation.
And then there's Nokia. This company used to be a Wall Street darlings years ago, but it has now become a case study for the board of Research in Motion (NASDAQ: BBRY). RIM is in a bit of a death spiral right now as it is forced to spend more money on marketing to make up for dying interest in its products. The firm, however, neither has a cost advantage nor the content necessary to compete against more popular models, like the iPhone. Channel inventories for RIM are much too high as retailers reduce the shelf space for BlackBerry. Meanwhile Nokia's earnings have generally beaten expectations, they are still in the process of a doubtful turnaround. Over the trailing twelve months, Nokia has lost $1.20 per share. It is expected to lose only $0.07 for 2013 yet ROA, ROE, and ROI still remain heavily in the negative double-digits. Analysts meanwhile put the target price below the current market cap while rating the stock a 3.3 out of 5 where "5" is a "sell".
To get a sense of where Nokia is going, look at the operational trends. FCF for the TTM months ending 2Q12 was $347 million, -$859 million for 1Q11, $989 million for 3Q11, and -$472 million for 2Q11. This is a volatile ride that is simply not worth backing when there are stocks as undervalued as Cisco in the same sector. If Cisco finds that it is undervalued, it may even buy some assets of Nokia to develop. While the upside from a strong Nokia turnaround may be good (the average PE multiple is 24x over the past 5 years), I would rather be on the sidelines than in the game. The grass is, after all, greener there with Cisco.
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