What follows is a list of firms engaged in the communications sector that have been dominated by bearish sentiments. In my view, Cisco (NASDAQ:CSCO) is meaningfully undervalued while risk exceeds reward for Alcatel Lucent (ALU) and Nokia (NYSE:NOK). While rising consumer expenditures will buoy up the sector at large, these benefits will disproportionately accrue to firms with the greatest catalysts and momentum.
Cisco trades at a respective 12.2x and 8.6x past and forward earnings with a dividend yield of 1.9%. To value Cisco, I employ a DCF model. In this model, I make several assumptions: (1) 8.7% per annum growth over the next half decade, (2) operating metrics stay at historical levels, (3) 2.5% perpetual growth, and (4) and a discount rate of 10%. Based on these assumptions, I find the intrinsic value of the stock to be $28.28 for 71.7% upside.
While recent results have been very disappointing, the recent 17.9% decline from one month ago was overblown. Free cash flow is still looking strong in light of how lean operations are. Going forward, much of the company's value will be seen as a turnaround play. Although the 1.2, by itself, does not suggest the opportunity for high-risk adjusted returns, the fact that the market assumes an 18% discount rate based on my above assumptions does. Accordingly, reward far exceeds risk.
Nokia is a bit of zombie stock, but the stock is nevertheless near its 52-week low and is valued at just one-third of what it was at its 52-week high. Consensus estimates forecast a rocky ride with negative EPS of $0.22 in 2012 turning positive at $0.10 in 2013. Assuming a multiple of 16x and a conservative 2014 of $0.24, the stock would hit $3.84 for 34.7% upside.
While this reward may easily attract back speculative investors when the economy fully recovers, I find that there is too much risk stemming from unstable fundamentals. Although the partnership with Microsoft is somewhat promising, earnings momentum is highly uncertain. The Street currently rates the stock nearer to a "sell" than a "buy" (source: NASDAQ).
Alcatel trades at a respective 4x and 6x past and forward earnings with no dividend yield. Consensus estimates forecast Alcatel's EPS declining by 57.4% to $0.20 in 2012, growing by 20% in 2013, and then falling back down to $0.08 in 2014. With management offering no dividend yield, the stock having a beta of 1.9, and the Street rating the company nearer to a "sell" than a "buy", I recommend avoiding the company.
With that said, Alcatel offers a speculative way to buy and sell based on the volatile ride. Investors who have a strong understanding of the business should capitalize on overblown dips. In a stock as risky as Alcatel's, any signs of weakness will tend to dramatize the explicit and implicit costs pertaining to those weaknesses. Put differently, the potential in exploiting market behavioral anomalies is very real and significant. For value investors, the idea of day trading, however, is ineffective as a long-term investment strategy.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.