But how, you will ask, does one decide what [stocks are] "attractive"? Most analysts feel they must choose between two approaches customarily thought to be in opposition: "Value" and "growth" ... We view that as fuzzy thinking ... Growth is always a component of value [and] the very term "value investing" is redundant. --Warren Buffett, Berkshire Hathaway annual report, 1993
We take Buffett's thoughts one step further. We think the best opportunities arise from a complete understanding of all investing disciplines in order to identify the most attractive stocks at any given time. We therefore analyze each stock across a wide spectrum of philosophies, from deep value through momentum investing.
This involves performing significant valuation analysis, both on a DCF and relative value basis, as well as a strong consideration of the firm's fundamentals (cash flow, risk, etc.), technicals and momentum indicators. The best stocks, we believe, will be attractive from a number of investment perspectives -- from value through momentum (hence our name, Valuentum). On the other hand, the worst stocks will be shunned by most investment disciplines and display expensive valuations and poor technicals and momentum indicators.
As part of our process, we employ a discounted cash-flow model to arrive at a fair value estimate for every company within our equity coverage universe. In Juniper's (JNPR) case, we think the shares look fairly valued at today’s prices. Our fair value estimate for Juniper is $22 per share, near where it is currently trading. In the spirit of transparency, our DCF valuation model template can be found here. We make this template available to investors, and it can be re-used to value any other operating firm in your portfolio.
Source: Valuentum Securities, Inc.
We think Juniper is worth $22 per share, which represents a price-to-earnings (P/E) ratio of about 19.2 times last year's earnings and an implied EV/EBITDA multiple of about 10 times last year's EBITDA. Our model reflects a compound annual revenue growth rate of 10% during the next five years, a pace that is lower than the firm's 3-year historical compound annual growth rate of 13%.
Our model reflects a 5-year projected average operating margin of 21.5%, which is above Juniper Networks's trailing 3-year average. Beyond year 5, our valuation model assumes free cash flow will grow at an annual rate of 3.3% for the next 15 years and 3% in perpetuity. We employ an 11.8% weighted average cost of capital to discount future free cash flows.
Future Path of Fair Value
We estimate Juniper Networks' fair value at this point in time to be about $22 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart below compares the firm's current share price with the path of Juniper Networks's expected equity value per share over the next three years, assuming our long-term projections prove accurate. The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence.
This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change. The expected fair value of $31 per share in Year 3 represents our existing fair value per share of $22 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.
All things considered, we think the shares are fairly valued today and expect the firm's equity to roughly keep pace with the return of the overall market in periods ahead. If the shares fell below $15 (the lower end of our fair value range), we'd consider adding Juniper to the portfolio in our Best Ideas Newsletter.