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Technology Stocks : EMC How high can it go? -- Ignore unavailable to you. Want to Upgrade?

To: JDN who wrote (4972)	3/18/1999 5:16:00 PM
From: Murrey Walker	Read Replies (1) \| Respond to of 17183

JDN...If I understand you, I would guess that these folks are “locking in“ profits (and taxes). If they buy back that position, they are automatically changing their cost basis for capital gains purposes. Does that kinda make sense?

To: JDN who wrote (4972)	3/18/1999 7:47:00 PM
From: Erwin Sanders	Respond to of 17183

Is EMC's price too high? Answer: not likely - Part 1 ===================================================== As EMC is hitting new highs everyday, it is natural to wonder whether one should hold or sell. I am not concerned here with short-term trading for those who follow Traders' Astrology (incidentally, for many TA = Technical Analysis). I am more concerned with the concept of owning a business and therefore with projections of future cash flow and earnings per share. The following are my thoughts. Part 1 lays out a methodology for evaluating the price of a stock. Part 2 applies this to EMC's share price Ignoring market and sector trends, the price of a share should equal the present value of the future cash flows that this share generates. Cash flows are harder to predict than earnings ( hard enough as they are), and the price can be estimated as the present value of the future earnings that this share generates. To calculate this, the three parameters needed are: 1. number of years to project 2. earnings growth rate 3. interest rate for discounting Number of years to project ------------------------------- Classical formulas often imply perpetuity. I do not agree with this – companies do not last forever. Besides, even if they last a very long time, who can predict earnings, say 20 years away? I often use 15 years. By not using more years, one is adding a reasonable dose of conservatism. Earnings growth rate ------------------------- This is the trickiest. We can get some idea from analysts, company statements and market trends for the next five years but not beyond. I would therefore like to look at the first five years separately from the years thereafter. Interest rate -------------- One should use a long-term treasury interest rate – say 6%. Some would argue that a higher interest rate should be used to reflect the greater uncertainty with corporate profits than with the Government's ability to repay debt. I would argue that any such uncertainty should be factored into the projected growth rates (i.e. use risk-adjusted earnings projections) I have applied this methodology to historical values for the S&P 500 index (with the hindsight of knowing the future earnings per share) and have found that the price projected by this model matches closely with the S&P index. Regards, Erwin

To: JDN who wrote (4972)	3/18/1999 7:54:00 PM
From: Erwin Sanders	Read Replies (2) \| Respond to of 17183

Is EMC's price too high? Answer: not likely - Part 2 ===================================================== First, let us use the above methodology to blow away immediately the myth of a much used measure – the PEG. Many, including market analysts, believe that the PE of a stock should be very close to the earnings growth rate. There is no basis to this theory (someone please educate me if there is). It has never been clear to me in the first place if the earnings growth rate is the current year's or the long-term. Neither makes any sense. If it were the former, clearly the long-term growth rate should be more relevant to the price of a stock then just one year's growth (although important). Let us use our model to show how off base the PEG theory is. The P/Es (forward P/Es) for various long-term growth rates are as follows. Results are shown for two interest rates. l-t growth - interest=6% - interest= 10% 0% - 9.7 - 7.6 5% - 13 - 10 10% - 19 - 14 20% - 39 - 27 30% - 85 - 56 The PE ratio should always be higher than the long-term growth rate (unless the company is losing money), and much higher in the case of high growth companies. EMC's price using the model --------------------------- For projecting EMC's future earnings, I have used the following assumptions: 1. 1999 EPS of 1.99 (consensus estimate – likely to be low). 2. Growth rate for first five years: 40% per year. Company statements indicate 35% growth in revenue. Many believe they may be understating, plus margins are improving due to growth in software, so I am using 40%. 3. Growth rate after 5 years: 20% per year (which is still extremely good). This is pure speculation. Any thoughts/discussion on this would be appreciated. 4. Price = discounted value of future earnings for 15 years, using an interest rate = 6%, as discussed in Part 1. The above assumptions produce a price of $158 (pre-split), growing to $415 in five years' time 21% per year increase). Now, if you were reasonably certain that the price will be close to $415 after five years, would you not borrow money at 10% to buy more shares? The break-even price for one not to do so ($415 discounted at 10% for five years) is $257. One can argue that this “modified”price of an EMC share should be $257. The target price range can then be thought to be $158-$257. Now, what if interest rates all of a sudden go up to 10%? The target price range then becomes $108-$178. If interest rates stay at 6%, but the long-term growth rate after five years is 10% per year, not 20%, the target price range becomes $107-$123. I will leave it to each of you to form your own judgement as to whether EMC's current share price is justified. I would also welcome any thoughts on the methodology or assumptions. Regards, Erwin