Shareholders of Corning (NYSE:GLW) have had a very difficult year. In the past 52 weeks, the stock price has declined nearly 23%, shedding nearly $4 billion in shareholder value. This decline has been slightly mitigated by an increase in dividend yield; however, many investors have experienced large losses. In this article, I will make the case that Corning could potentially face further downside in the near future.
Buying a Share of Earnings
The first item we will examine in this analysis is the price-to-earnings ratio. P/E is a simple ratio that essentially represents how much the market is willing to pay to purchase a dollar of the company's earnings. P/E is a popular valuation metric, and it can give important insight into determining the relative worth of an organization.
In traditional fundamental analysis, a P/E ratio of below 20 represents a valuable organization. However, I believe that a more relevant method of examining P/E it to evaluate the ratio in light of the industry in which the organization participates. Corning's current P/E ratio is 8.42. Using traditional fundamental analysis, this represents an excellent purchasing opportunity. The picture becomes even more desirable in light of an examination of the technology sector. The average P/E ratio of the technology sector is currently 17.6. This essentially means that on average individuals are willing to pay $17 for each dollar of a standard technology company's earnings.
For Corning, however, the market is only willing to pay $8.42 for the same amount of earnings. This essentially means that investors are willing to pay on average two times as much for the earnings of the technology sector than for the earnings of Corning. On the surface, this situation would seem to dictate that Corning is a solid purchasing opportunity, but I argue that Corning is actually overvalued and that the market has not fully priced in the decline in Corning's competitive edge.
Record of Returns
In order to determine the proper valuation of Corning, we should examine its organizational returns in light of share price performance. Specifically, we will examine the return on assets and return on equity. These two ratios give investors valuable insight into how well the company actually utilizes assets and investor capital to generate revenues. In order to examine these returns, we will look at them in light of how Corning's stock price has historically responded to these returns.
The above chart shows the historical return on assets and return on equity compared to the historical monthly stock price of Corning. The first item of interest is found at time period A on both charts. During this time period (leading up to the financial crisis), Corning experienced a peak in return on assets and return on equity coinciding perfectly with a peak in stock price. Immediately following this peak in asset and equity returns, Corning's share price collapsed nearly 70% until the organization bottomed out at point B. At point B, Corning once again generated growing returns on its assets and equity, leading to a strong growth in share price. Between points B and C, returns began declining once again, leading to the current environment.
The points we are most interested in are B and C. At point B, the share price, return on assets, and return on equity were all at five-year lows. Not only were the financial markets as a whole collapsing during this time period, but Corning was also struggling from an organizational standpoint in that it was unable to generate significant returns as compared to its previous performance. These two factors (market influence and organization performance) led to the stock price bottoming out at around $8 per share. As we examine the current data at point C, something very interesting comes to light. The current return on assets and return on equity are less than they were at point B. This essentially means that the organization is actually performing worse now than it was during the worst days of the financial crisis. However, the market price per share is actually up 50% from the market low!
The difference between share price and organization returns represents a clear divergence and an excellent trading opportunity. During the worst days of the financial crisis, Corning was still earning decent returns on its assets and equity. Today, Corning's return on assets and equity are less than they were during 2009; however, the share price is up more than 50% over this same time period. I believe that the market has caught on to the fact that it made a mistake by speculatively pricing Corning between the years of 2009 and 2011. Since the beginning of 2011, the stock price has fallen nearly 50% and I believe that further downside is entirely possible. Specifically, I see it as entirely possible that since Corning is generating a worse return then it did in 2009, it should be priced at 2009 levels or lower.
This pricing target is also justified from a P/E standpoint. The P/E ratio in 2009 for Corning was near 3.5, and it is currently around 8.4. Share price would need to fall nearly 60% for the market to once again value Corning at levels comparable to today's fundamental performance. This 60% decline in share price would put the stock right where it historically belongs. This forecast price is the price that the market was willing to pay per share when growth rates were this low in 2009. That said, my target on the stock is between $7 and $8 per share over the next few quarters.
A Record of Mistakes
As I noted at the beginning of this article, Corning has increased its dividend yield. I believe that this is a serious mistake and represents a short-sighted management rather than a forward-looking organization. Every dollar that management decides to pay out as dividends is a dollar that cannot be invested into future corporate growth. Dividends are a very powerful signaling device in that they tell shareholders that management believes the best use of its excess capital is to attempt to appease shareholders, rather than pouring capital back into expanding business operations and strengthening organizational competitive edge.
As can be seen in the chart above, Corning has increased its dividend yield significantly over the past five years. I believe this is a very poor decision and that these dividend dollars are better spent attempting to expand business operations and capture new customers.
I will leave readers with one final thought: Do you care that the dividend yield has doubled to 2.52% in the past year and a half when, over the same time period, the share price has fallen nearly 50%? Wouldn't you rather have this money spent on growing the organization and subsequently experiencing share price growth due to legitimate business expansion?