Sirius XM (NASDAQ:SIRI) is the most heavily-traded stock in the market. As of Monday, the volume of trade reached 136.94 million, second to Bank of America (NYSE:BAC) which traded with a volume of 397.14 million. It is one of the most highly-speculated and manipulated stocks in the market. The stock lost 20.83% in the last month, while returning 72.73% in a year. It was a good short 3 months ago with no reported profits and a price of $2.2. However, it recently reported some good profits and is trading 30% below its 52-week high, which makes it a fairly-valued stock.
As of August 22, Sirius XM was trading at $1.71 with a 52-week range of $0.95 – $2.44. It has a market cap of $6.8 billion. Trailing twelve month P/E ratio is 47.6, and forward P/E ratio is 27.1. P/B, P/S, and P/CF ratios stand at 13.6, 3.9, and 19.3, respectively. The 3-year annualized revenue growth stands at 45.1%. Operating margin is 18.9%, and net profit margin is 8.1%. The company has a high debt-to-equity ratio of 5.4. Sirius XM does not have a dividend policy yet.
Sirius XM has a 3-star rating from Morningstar. Out of 10 analysts covering the company, 6 have buy, 2 have outperform, and 4 have hold ratings. Wall Street has diverse opinions on Sirius XM’s future. The bottom line is -25% growth, whereas the top-line growth estimate is 125%. Morningstar lists the average five-year annualized growth forecast estimate as 75.5%. However, given the 3-year annualized revenue growth of 45.1% and the gigantic amount of debt in the balance sheet, I think a 30% annualized EPS growth estimate is more reasonable.
What is the fair value of Sirius XM’s given the forecast estimates? In this article, the tenth in the series, I will show a step-by-step calculation of Sirius XM’s fair value using discounted earnings plus equity model.
Discounted Earnings Plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E_{0} + E_{1 }/(1+r) + E_{2 }/(1+r)^{2} + E_{3}/(1+r)^{3} + E_{4}/(1+r)^{4} + E_{5}/(1+r)^{5 } + Disposal Value
V = E_{0} + E_{0 }(1+g)/(1+r) + E_{0}(1+g)^{2}/(1+r)^{2} + … + E_{0}(1+g)^{5}/(1+r)^{5} + E_{0}(1+g)^{5}/[r(1+r)^{5}]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E_{0}(1+g)^{5}/[r(1+r)^{5}] = E_{5} / r
While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. I used an annualized EPS growth estimate of 30% for the next 5 years (Finviz also gives 30% EPS growth for the next 5 years). You can set these parameters as you wish, according to your own diligence.
Sirius XM’s Valuation
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate.
Since we are in the middle of the year, it will be more feasible to take the average of ttm EPS of $0.03 along with the mean estimate of $0.08 for the next year.
E_{0 }= EPS = ($0.04 + $0.08) / 2 = $0.06
Wall Street holds diversified opinions on Sirius XM’s future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Finviz offers an annualized five-year growth forecast of 30%. Book value per share is $0.12.
The rest is as follows:
Fair Value Estimator | ||
V0 | E_{0 } | $0.06 |
V1 | E_{0 }(1+g)/(1+r) | $0.07 |
V2 | E_{0}((1+g)/(1+r))^{2} | $0.08 |
V3 | E_{0}((1+g)/(1+r))^{3} | $0.10 |
V4 | E_{0}((1+g)/(1+r))^{4} | $0.11 |
V5 | E_{0}((1+g)/(1+r))^{5} | $0.13 |
D | E_{0}(1+g)^{5}/[r(1+r)^{5}] | $1.20 |
BV | Equals | $0.12 |
Fair Value Range | Lower Boundary | $1.76 |
Upper Boundary | $1.88 | |
Potential | 9.70% |
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5 year discounted-earnings-plus-book-value model, the fair-value range for Sirius XM is between $1.76 and $1.88 per share. As of Aug 22, Sirius XM was trading at a price of $1.71. I am not a big fan of Sirius XM and I think their business-growth model is not sustainable. There are many free alternatives to Sirius XM. Anything that can play music could be a serious threat to Sirius XM, including-- but not limited to-- iPhone, iPod, internet radio, local radio, am radio, and cable radio.
Nevertheless, Monday’s closing price of $1.71 indicates that the stock is undervalued. Based on my FED+ fair value estimate, Sirius XM has a fair-value range of $1.76 - $1.88. The stock has 10% upside potential to reach the upper boundary of its fair-value range. For those interested in Sirius XM, the recent sell-off offers an entry point below fair-value.
O – Metrix Confirmation
If the math above looks too complicated for you, try estimating the fair value using the O-Metrix as such:
O-Metrix = [(Dividend Yield + Growth Estimate) / (P/E Ratio)] * 5
Dividend Yield: Higher is better.
EPS Growth: Higher is better.
P/E Ratio: Lower is better.
The back-testing of this valuation technique on 40 large-caps shows that O-Metrix works very well over the long-term, such as five years. I am also continuously checking on specific sectors, and the formula works very well so far.
What Is The O-Metrix Score?
- Sirius does not have a dividend policy. Therefore, the yield is 0.
- Growth estimate is the same as the discounted earnings model and is equal to 30%.
- Since we are at the middle of the year, taking the average of ttm [57] and forward [21.38] P/E ratios will smooth the results. Thus, the average P/E ratio to be used in the model is 39.19.
O-Metrix = [(30) / (39.19] * 5 = 3.82
Depending on the benchmark chosen, the market has an O-Metrix score range between 4 and 5. Sirius XM’s O-Metrix score of 3.82 is below the fair-value range. Back-testing of this ranking system shows that companies with higher-than-average O-Metrix scores beat the market with lower volatility. At a price of $1.71, the company is trading within the D-Grade, below-average-return zone. However, the O-Metrix score does not consider the extremely bullish investor sentiment behind Sirius XM.
click on image to enlarge
Summary
Sirius XM’s stock has always been priced at a premium due to its high growth potential. The average P/E ratio in the last 5 years was negative. The stock has a relatively high PEG ratio of 1.9. It is trading with a high P/E ratio of 57, but the forward P/E ratio falls to 21.18. I used an annualized EPS growth of 30% for my fair-value estimate. If you believe at a growth rate higher than 30%, than Sirius XM is your stock.
As of Aug 22, Sirius XM was trading at $1.71, slightly lower than my fair-value range of $1.76 - $1.88. Its price to book ratio of 14.25 is well-above the market. It is a very risky company to invest in. Although the year to date return is 4.91%, the stock reversed its upward trend, losing 20.83% in a month. It has a pretty high Beta of 1.95. Nevertheless $1.70 is a strong resistance point. For the short-term speculators, I would not recommend selling Sirius XM as long as the price stays above $1.70. For long-term investors, any price below $1.88 is a good entry point.
You can download FED+ Fair Value Estimator, here.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.