EMC Corporation (EMC) was founded in 1979 by two entrepreneurs, Richard Egan and Roger Marino. As a small startup, innovating 64-kilobyte memory boards was the first initiative. Later, the entrepreneurs moved on to developing computer data storage types and networked storage platforms. In the early 1990s, EMC became a multi-billion dollar company. Headquartered in Hopkinton, Massachusetts, EMC provides products under several segments ranging from information security to enterprise content management and cloud computing services. After the acquisition of VMWare (VMW) in 2004, EMC became one of the top players in cloud computing services. The company employs more than 53,000 employees worldwide. EMC consistently scores among the best places to work. In March 2010's Fortune List of the "World's Most Admired Computer Companies", EMC settled as the third in the list. The company is a truly global tech giant with worldwide operations. In 2011, EMC announced record revenue of $20.01 billion, $5.7 billion operating cash flow and $4.4 billion free cash flow.
As of the time of writing, EMC was trading at $28.87 with a 52-week range of $19.84 - $30.00. The company has a market cap of $59.81 billion. Trailing twelve month [ttm] P/E ratio is 26.29, and forward P/E ratio is 14.44. P/B, P/S, and P/CF ratios stand at 3.1, 3.2, and 11.2, respectively. Operating margin is 17.21%, and net profit margin is 13.04%. With a low debt/equity ratio of 0.18, the company seems to have a minor debt issue. EMC does not have a dividend policy yet.
EMC Corporation has a 3-star rating from Morningstar. Out of 12 analysts covering the company, 9 have buy, 2 has outperform and 1 has hold ratings. Wall Street has optimistic opinions about EMC's future. Average five-year annualized growth forecast estimate is 16.30%.
What is the fair value of EMC given the forecast estimates? We can estimate the fair value using discounted earnings plus equity model as follows.
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 = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value
V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / 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. To be as objective as possible, I use Morningstar data for my growth estimates. You can set these parameters as you wish, according to your own diligence.
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year.
E0 = EPS = ($1.10 + $2.00) / 2 = $1.55
Average five-year growth forecast is 16.30%. Book value per share is $9.25.
The rest is as follows:
Fair Value Estimator
Fair Value Range
(You can download FED+ Fair Value Estimator, here.)
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 EMC is between $28.30 and $37 per share. At a price of $28.87, EMC is trading at the lower end of its fair value range.
As one of the largest provider of data storage platforms, EMC is a direct competitor with several giants in this field. IBM (IBM), NetApp (NTAP), and Hewlett Packard (HPQ) are among other tech titans in the data storage business. I think the macroeconomic outlook is strongly positive for these companies. Given the increasing need for data storage systems, the demand for these products will keep rising. The rising demand will in turn boost the profits of these companies. Hewlett Packard is my favorite among this group, since it has the lowest trailing and forward P/E ratios.
Technology stocks are pretty cheap in general, but EMC is trading at a fair value. At the current prices, EMC is almost at the top of its 52-week trading range. Despite collapsing to $20 from $28 in the middle of the last year, EMC showed a magnificent performance in this year. The stock is up by almost 34% since January. Its fundamentals look strong enough to encourage long-term investors. Based on my FED+ valuation, EMC has up to 23% upside potential. I rate EMC as a buy. However, considering the recent upward movement of the stock, it might be a good idea to wait for a pull back.