Jubak article in Microsoft Investor. $55 ASND target and interesting analysis
[Personally, because I believe ASND and analysts are lowballing all estimates at this point, I'd just take Bernstein's current $1.75/sh estimate (possibly low) for FY99 and multiply by 40/50 PE (lower than CSCO) to get $70/$87.50 or roughly a double in 1.5 years. And, in the bullish case, if ASND earns $2.00/sh in FY99, it would be $80/$100. It's nice to dream. djane]
investor.msn.com
Jubak's Journal
When to break the rules
Knowing the basic principles of investing is key -- but it's the
exceptions that produce profit and loss. Take earnings growth, for
instance.
By Jim Jubak
It's pretty easy to learn the rules of investing. It's figuring out the
exceptions that's hard.
You know what I mean. A high price-to-earnings ratio is bad --
except when it signals a company's impending turnaround. Look
for companies with high profit margins -- unless the high margins
are about to attract bigger competitors. Avoid companies that
show years of big losses -- except in industries where stocks are
valued on cash flow and not earnings.
That makes the process of learning how to invest discouragingly
hard -- and often dishearteningly unprofitable. Lots of investors
begin by learning "the rules" from an expert or a book only to
discover by experience that the exceptions can produce
unexpected profits or losses. Experience is a great teacher if
you're learning how to ride that first two-wheeler on a grassy
suburban lawn that will cushion the tumbles. But for investors, the
tuition can get pretty expensive very quickly. Exactly how many
stocks can you afford to watch blow up on you?
I don't think an investor can escape all those costs and pain. But I
think that by understanding how all the pieces of an investment
strategy fit together -- from collecting raw data to drawing a
conclusion -- an investor can avoid some of the tuition that
experience charges. Truth is that in investing, even the exceptions
have rules.
Details
Quote Detail
Earnings Estimates
Quote Detail
Earnings Estimates
Quote Detail
Earnings Estimates
How do you go about developing that first rule and then the "rules
of exception" that you need in order to produce profits rather than
losses from your system? It's actually less daunting than it
sounds. Let me show you what I mean by taking you through a
very simple rule -- how to calculate a target price using projected
earnings per share and a projected price-to-earnings ratio -- and
its "rules of exception."
(Laying out the "rules of exception" in setting a target price will
take me two columns. Today I'll deal with the rules for earnings; in
the next column I'll tackle the rules for price-to-earnings ratios.)
The formula for calculating how much a stock should be worth in a
year is pretty simple. Estimate earnings per share a year from
now and then multiply that number by the stock's
price-to-earnings ratio. To set a target price for Tellabs (TLAB), for
example, just go to Investor's Quote Detail to get the current
price-to-earnings ratio (48.7). Then click on the earnings
estimates section under Analyst Info for next year's earnings per
share ($1.87 after a little massaging to get the time periods in
line). Next June, Tellabs should be worth $91.09, a tidy 36% gain
from the current price.
I use that method for calculating a target price for a stock that I'm
thinking about buying. The results seem to have a satisfying
precision -- Tellabs, a Jubak's Picks selection, is worth $91.09
and not a penny more or less -- and it's easy to apply this system
to stock after stock. I've put the crucial numbers in a table. (Those
readers with Excel can download a simple spreadsheet to do the
calculation). I've included data on two other Jubak's Picks,
Ascend Communications (ASND) and Texas Instruments (TXN).
The numbers tell me that Ascend should trade at $55.51 a year
from now -- a gain of 29%. Texas Instruments, on the other hand,
will reward an investor with a 26% gain after a year. It should sell
next June for $67.01. Any doubt about how to rank these three
stocks? Tellabs is clearly the best buy and Texas Instruments the
laggard.
Basic target-price estimate
Company
Current
Price
(5/27/98)
Current
P/E
Projected
EPS
year from
now
Target
Price
Ascend (ASND)
42.94
98.00
$0.57
55.86
Tellabs (TLAB)
66.75
48.70
$1.87
91.07
Texas
Instruments
(TXN)
53.19
12.70
$5.28
67.06
Really? How much do I really trust these numbers? On the face of
it, they don't make much sense. Why, for example, is Texas
Instruments trading at a price-to-earnings ratio of 12.7 and
Ascend at a price-to-earnings ratio of 98 when the growth rates
and the potential returns on the stocks are so different?
Time to apply the rules of exception to the earnings part of the
formula. (I'll include tables and spreadsheets along the way to
illustrate each step.)
Financial
Statements
Ascend
Tellabs
Texas Instruments
1) Scrub the data: Is it accurate for your purposes? As is true
with most investment measures, there are a number of equally
"correct" ways to state earnings. Only one format, however, works
well in the formula you're using now. Since you're interested in
projecting the real growth of the company's business, you have to
restate earnings to eliminate the effect of one-time events such as
the sale of a division or a big write-down of inventory. (Investor
states earnings "as reported" by the company. To restate those
earnings to eliminate one-time gains, you'll have to look at the
company's financial reports for the last four quarters. What to add
back in or subtract is somewhat of a judgment call. If the
company's basic business is showing a loss, I leave the figure
alone, for example. But if that basic loss is increased by charges
for laying off workers or writing off inventory, I add those amounts
back in.)
Sometimes there's nothing to correct. Tellabs, for example, didn't
report any one-time gains or charges in the last year. But for
Ascend and Texas Instruments, the corrections are substantial.
Ascend took big write-offs last year that reduced its as-reported
earnings to just 48 cents over the last four quarters. Without the
charges, the company earned $1.02 a share. Texas Instruments
recorded a huge gain from the sale of some division -- without
that, earnings were $2.12 a share instead of $4.29.
Once you've restated earnings, the stocks' current P/E ratio will
change too. Ascend really trades at 45.6 times restated earnings
-- not at a multiple of 98. Texas Instruments has a restated P/E
ratio of 25.9, not 12.7. Both stocks, the first rule shows, trade
more like the market as a whole than at first glance.
Growth Rates
Ascend
Tellabs
Texas Instruments
2) Check for historical consistency. Exactly how likely is it that
the company will achieve the growth rate that analysts are
projecting? Analysts look like they're actually being pretty
conservative with both Tellabs and Texas Instruments if history
counts for anything. Tellabs has grown earnings by 64% a year
over the last five years -- but analysts are projecting just 29%
growth in the next year. Texas Instruments racked up 44%
earnings growth in the last five years -- the projection for next year
is just 23%. (Ascend doesn't have a five-year earnings track
record for comparison.)
I like to check for consistency going forward as well as backward.
Analysts peg Ascend's growth for the next year at 18%, but at
39% annually over the next five years. [Want to bet that the next 5 years will be closer to 39% or 18%...] Tellabs and Texas
Instruments show a remarkable consistency -- their projected
five-year growth rates are within a point or two of next year's
projected rate.
You can draw your own conclusions, of course, but here are
mine: I think it likely that analysts are underestimating all three
stocks' earnings growth. I doubt that growth at Tellabs is about to
drop by half, or that Ascend will grind out just 18% for the next
four quarters and then suddenly step on the gas. On the historical
evidence alone, I'd up Ascend's growth for the next year by 2
percentage points to 20%, Tellabs by 5 percentage points to
34%, and Texas Instruments by 2 percentage points to 25%. You
can see the resulting Target Prices in this table.
Target-price estimate with recalculated P/E and EPS
Company
Current
Price
(5/27/98)
Recalculated
P/E
Recalculated
EPS
year from
now
Target
Price
Ascend
(ASND)
42.94
45.60
$1.22
55.63
Tellabs
(TLAB)
66.75
48.70
$1.94
94.47
Texas
Instruments
(TXN)
53.19
25.90
$2.65
68.64
3) Compare the variables in your formula to other data on
the company. For example, it's hard to increase earnings when
profit margins are falling, or when sales are flat. So I'd certainly
feel more confident in my projections of earnings growth if sales
and net profit margin were headed in compatible directions.
Profit Margins
Ascend
Tellabs
Texas Instruments
The story looks decent at Texas Instruments -- sales have been
pretty flat in the last year thanks to trouble in the
personal-computer industry, the customer for the company's
memory chips. But I like what the company's restructuring has
done to the bottom line. Net profit climbed to 18% last year, up
from the five-year average of just 8%. No reason to change my
prior assessment of earnings growth for the company, I'd say.
At Tellabs, the picture is more positive. Sales growth did indeed
taper off to 33% in the last year from 35% over the last five, but
that's still well above the earnings growth rate I'm projecting. And
margins are climbing, as they often do when sales grow and
companies can spread fixed costs over a bigger revenue base.
With margins climbing to 21% from 17% over the last five years,
I'd tack another 2 percentage points onto the company's earnings
growth rate.
Ascend doesn't have a meaningful five-year track record. But I
don't see anything in the sales data for the last year to raise a
flag. Sales grew by 51%, well above the earnings growth rate I'm
projecting. The company's net profit margin of just 8% does
concern me, but since the company is in recovery from a couple
of grim quarters, I watch it carefully rather than downgrade my
projections. All in all, I'll just leave my projected earnings growth
rate alone.[Note: ASND operating model has profit margin in mid-20% range]
So what's the end result of applying these three "rules of
exception"? The relative merits of the three stocks as investments
haven't shifted much. They've each gotten a little more attractive,
in fact, with the projected return on Tellabs, for example, shooting
up to 44% from 36%.
Target-price estimate with further-refined EPS Estimate
Company
Current
Price
(5/27/98)
Recalculated
P/E
Further
Refined
EPS
Estimate
Target
Price
Ascend
(ASND)
42.94
45.60
$1.22
55.63
Tellabs
(TLAB)
66.75
48.70
$1.97
95.93
Texas
Instruments
(TXN)
53.19
25.90
$2.65
68.64
Users with an Excel-compatible spreadsheet program can do their own
calculations using the spreadsheet that was used in the calculation of these
prices. (4k .xls file)
But it's too soon to draw final conclusions. We're just halfway
home. I've given you some good rules for how to look at earnings
and earnings growth, I hope. Next column, it's time to tackle an
even thornier subject -- projecting a price-to-earnings ratio. |
