Winning & Losing Communication Stocks
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In light of increasing innovation in telecom and communications, the sector is bound to create winners and losers. I encourage buying stocks that offer strong margins of safety to account for the high-risk environment. The stocks to avoid are those that have flippantly changed corporate strategy--a signal that the fundamentals are weak.
At a respective 11.7x and 8.4x past and forward earnings (versus a historical 5-year PE multiple of 16.6x), Cisco is quite cheap for such a brand name stock. The communication device firm offers a 3.2% dividend yield, which is well supported by a payout ratio of 18.7% and a quick ratio of 3.4. The stock is more or less between its 52-week high and low with a spread of ~35%. What really attracts me to the stock is not the $21.79 price target on the Street, but rather the amount of free cash flow it is generating.
For the twelve months ending 2Q 2012, Cisco generated $10.4 billion in free cash flow. That comes out to a strong 11.2% yield against market capitalization. Meanwhile, earnings have been consistently above expectations over the last 5 quarters for an average beat of 8.3%. Analysts forecast Cisco growing EPS by 8.7% annually over the next 5 years, which will be enough to drive out performance. Assuming expectations are met, 2016 EPS will come out to $2.68. At a multiple of 13x, this translates to a future stock value of $34.84. Discounting backwards by 10% yields a present value of $21.63 for around a 25% margin of safety. When you factor in the dividend yield of 3.2%, risk/reward becomes highly compelling.
In contrast, Juniper is not worth an investment despite analyst forecasts for 14% annual EPS growth over the next half decade. At 15.8x forward earnings, no dividend yield, and limited free cash flow generation, the downside is pretty significant. Moreover, if you're long the wind is not exactly on your side given that analysts currently rate it closer to a "sell" than a "buy. While the company may have beaten analyst expectations by 40% in 3Q12, performance as a whole has been spotty over the last 5 quarters, with two earnings misses.
In addition, I am also concerned about the company's change in strategy. While it won't exit the CDN business, they are eliminating BitGravity's CDN technology. The decision to not build a complete CDN and focus on core media flow delivery signals, to me, competitive pressure.
Alcatel Lucent (NYSE: ALU) Quite Risky
When it comes to risky stocks, few carry as much as volatility as Alcatel. It has slid 62.4% from its 52-week high and now trades at 14.3x past earnings. Analysts expect EPS to fall by 5.6% annually over the next half decade rate it a 3.5 out of 5, where "5" is a "sell."
In addition, momentum hasn't exactly been great. The stock fell 10.6% after reporting weak recent quarterly earnings results. During this quarter, the company lost $188 million - well below consensus (EPS of -$0.06 came $0.02 short). Operators have been scaling back network investment so much that management has looked towards cost cutting measures to hold up the bottom-line. The top-line declined 7.1% to $4 billion, and the lack of emerging market exposure is proving to be a major liability. CDMA is disappearing as Verizon starts phasing it out, and a weak transition from 3G to 4G networks is killing any investor excitement. A resent study by ABI Research showed that Alcatel placed fourth in the LTE market, which many regard as a duopolistic industry.
Volatility should also complicate the company's ability to gain attractive financing that will enable it to successfully turn around the business. The last two quarters have been substantially below expectations, and there will be substantial downward momentum as competition further rises.
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