Company earnings are very closely followed by many investors. Discounted earnings model is a popular model to estimate the worth of a company. The amount of future earnings from the business is estimated for each forecast period and discounted at the appropriate discount rate to determine present value. The present value of each period of estimated earnings for all future years is then added to determine the total present value.
The last step determines the perpetual value. It's the residual value of the business at the end of the period of years being estimated. This value is discounted to its equivalent present value and added to the present value of the future earnings to determine total intrinsic value. Some investors like adding the book value to this number; we intentionally eliminated the book value as we are evaluating the companies based on earnings power. This model is commonly used to price IPOs and to evaluate a company's worth in a M&A scenario.
A rule of thumb for stock valuation that is popular on Wall Street is to calculate the sum of the expected growth rate of a stock's earnings plus its dividend yield and divide this by its P-E ratio. The higher the ratio, the better, and the famed money manager Peter Lynch recommends investors select stocks with a ratio of 2 or higher and to avoid stocks with a ratio less than 1.
The following is the list of top 6 attractive technology sector companies in S&P500 valued based on both the above criteria.
*We assumed a discount rate of 12% and the growth will stabilize after the next 5 years and enter a constant phase.
Western Digital Corp (WDC): Western Digital Corporation and its subsidiaries provide solutions for the collection, storage, management, protection and use of digital content, primarily audio and video worldwide. The stock has a Return on Assets (ROA) of 15.1% and a Return on Equity (ROE) of 23.8%. WDC is trading with a Return on Invested Capital (ROIC) of 21.9%. The stock is expected to earn $8.54 per share next year. WDC is expected to grow at 15.17% over the next 5 years. The company is valued at $107.4 using the Discount Earnings Model (DEM). The company has a sum-of-growth and yield-to-PE ratio (GY2PE) of 2.84. WDC is currently trading at $40.15, raising $9.2 or 30% this year. WDC is trading at 50% discount levels.
Hewlett-Packard Co (HPQ): Hewlett-Packard Company offers various products, technologies, software, solutions and services to individual consumers and small- and medium-sized businesses, as well as to the government, health and education sectors worldwide. The company has a ROA of 7.8% and a ROE of 22.0%. The company is trading with a ROIC of 15.3%. HPQ is expected to earn $4.42 per share next year. The company is expected to grow at 3.89% over the next 5 years. The stock is valued at $44.4 using DEM. The company has a GY2PE of 1.01. HPQ is currently trading at $24.57, falling $2.1 or 7.7% this year. HPQ is trading near its book and way below its earning potential.
Xerox Corp (XRX): Xerox Corporation is a global document management company that manufactures and sells a range of color and black-and-white printers, multifunction systems, photo copiers, digital production printing presses, and related consulting services and supplies. XRX has a ROA of 2.2% and a ROE of 6.4%. The stock is trading with a ROIC of 3.3%. The company is expected to earn $1.24 per share next year. The stock is expected to grow at 7.00% over the next 5 years. XRX is valued at $13.3 using DEM. The company has a GY2PE of 1.27. XRX is currently trading at $8.42, raising $0.22 or 2.7% this year. XRX is trading below its book value and below its earning potential.
MEMC Electronic Materials (WFR): MEMC Electronic Materials develops, manufactures and sells silicon wafers. MEMC operates in three segments: Semiconductor Materials, Solar Materials and Solar Energy. WFR has a ROA of 0.8% and a ROE of 1.6%. The stock is trading with a ROIC of 1.4%. The company is expected to earn $0.61 per share next year. WFR is expected to grow at 2.93% over the next 5 years. The company is valued at $5.6 using DEM. The company has a GY2PE of .28. WFR is currently trading at $3.83, falling $0.26 or 6.4% this year.
SanDisk Corp (SNDK): SanDisk Corporation is engaged in designing, developing and manufacturing data storage solutions in a range of form factors using the flash memory, controller and firmware technologies. The company has a ROA of 18% and a ROE of 26.8%. The company is trading with a ROIC of 21.0%. The company is expected to earn $5.47 per share next year. The stock is expected to grow at 14.27% over the next 5 years. The stock is valued at $68.0 using DEM. The company has a GY2PE of 1.43. SNDK is currently trading at $50.73, raising $3.1 or 6.6% this year.
Jabil Circuit Inc (JBL): Jabil Circuit, Inc. is a provider of global electronic manufacturing services and solutions. The company provides electronics design, production, product management and aftermarket services to companies in the aerospace, automotive, computing, consumer, defense, industrial, instrumentation, medical, networking, peripherals, solar, storage and telecommunications industries. The company has a ROA of 4.5% and a ROE of 16.7%. The stock is trading with a ROIC of 9.6%. The stock is expected to earn $2.94 per share next year. The company is expected to grow at 10.90% over the next 5 years. JBL is valued at $34.2 using DEM. The company has a GY2PE of 1.23. JBL is currently trading at $26.92, raising $6.8 or 34% this year.