>What would you use as a "normalized" revenue/earnings for WIND upon which growth rate can be applied?
Ramsey, the exercise you posted showing WIND to be fully priced contains a series of slightly incorrect assumptions. With your assumptions, WIND will be worth $55.87 after four years, making the current price in the $40's appear high.
Let's look at your analysis in detail and fix it up.
1. You started with $.43 earnings and grew future earnings for 4 years ending with $1.51. Actually, the next year is almost over and we know FY 1998 earnings will be at least 63 cents. This means you should start with $.63 and project earnings for 3.5 years to get a new earnings estimate of $1.89 in 3 « years, which you would equate to a share price of $70.16. This is a little better, but there is more, lot's more.
2. This year's .63, and maybe a little more, equates to about a 46% EPS increase year-on-year, much better than your 37% assumption. Actually, this year's EPS increase represents a near-term low. For example, H&Q is thinking in terms of next year's increase being more in line with 67%, not 37%. (Your error was in using analysts' mid-term growth estimates applied to near-term estimates about which you know specific information.) We can correct this problem by starting with $1 assumed earnings (for 1 « years out) and projecting forward for 2 « years at 37% growth. This gives $2.19 in earnings, which you would equate to a share price of $81.26 in 3 « years. Actually, this is a decent return on current share price in the $40, but there is more.
3. Why did you use 37% just because that's what the analysts' indicate? Analysts' have significantly understated WIND out-year earnings for years. Frustration with analysts' estimates is the primary reason I started this thread 1 « years ago. After probing fundamentals of WIND and the huge embedded systems opportunity, I believe 37% mid-term growth understates WIND's performance expectations. If you agreed only to the extent of increasing 37% to 40% (which is consistent with First Call's estimates, incidentally), then you would estimate WIND's price downstream to be $92.76. Put in a more realistic 60% for the next few years, and you would get $194.29.
4. Now let's look at your PEG pricing model. Your model is a reasonable starting place for trying assess the "market price" of a high-tech stock. But the fact is, as illustrated nicely by Bargin Hunter in Post #2155, that high-growth companies are poorly valued using a linear PEG model. In other words, the market price of WIND might be around $200 in 3 « years, but its intrinsic value would, like today, be worth much more. The long-term investor values his/her stocks in terms of intrinsic value which always becomes recognized in time. This means WIND may only be valued by the market at about 5 times its current valuation in 3 « years, but long-term investors will know better. On the other hand, by then the market might value WIND closer to its intrinsic value, as it has been doing lately with more substantial companies like KO, G and MSFT. This is why I said "you" would value WIND at the various amounts. It is not at all clear that the market will ignore the consequences of non-linear super growth expected.
5. There are other details your PEG pricing model is neglecting that add value to the market's perception of WIND shares. For example, you should give credit for WIND's per share cash, since that is money in the bank to the investor. These details would move the downstream price up to an even $200.
6. What do you think the I2O, DSP and EID developments will contribute to EPS? These are not interesting announcement that portend a little more business. These announcements, and others made and coming, are consistent with the beginning stages of a primary wave in computing, one gigantically larger than anything ever encountered previously. I2O alone had 50 design wins in the single quarter ending in July 1997 - and its just starting. It is well within the realm of possibility that WIND will begin to exhibit hyper-growth starting next year, with its market price exploding by factors. Today's investor has an opportunity to take that bet with a downside expectation that he/she will return 5 to 1 within 3 « years. Not bad.
Despite all the wonderful opportunities I expect to open up for WIND, I remain sluggishly conservative in my estimates of future price performance. I only look for a modest 40% per year increase, which equates to $130 in 3 « years. Let me emphasize, however, this is not a price target, since WIND's market price radically understates its intrinsic value, now and probably for the foreseeable future.
Allen |
