DCF Valuation Portfolio: Results And Recommendations

by: Ricardo Espinosa

For the past year, I have performed several DCF valuations on several companies and published them on Seeking Alpha.

In this article, I will share the results of such valuations, and recommend a course of action for the stocks that were analyzed. Keep in mind that this is an exercise of how the stock market reacts to a stock´s fundamental value, and whether this happens is subject to much debate.

For easier access, a link to each valuation article is available in its corresponding target price.

The 3 scenarios used in DCF valuation: basic concepts

As I explain in my articles, I use three scenarios for valuating each company in the most objective way possible.

I will start with the "Negative scenario", which, of course, varies for each company but assumes that the current risks its industry´s competitors taking some of its market shares, growth or deceleration of revenues (depending on the company) and overall margin erosion for all companies.

The "Business as usual" scenario basically assumed that the company will keep performing as it has been for the last five years, most of the enterprises continuing its revenue and margin tendencies.

The "Optimistic scenario" basically assumed that the company will increase its revenues, keep or increase its gross and net margins and operating cash flows.

Each company had different assumptions regarding its future investing and financing cash flows depending on the company´s situation, but can be consulted in my previous articles of each company´s DCF valuation.

So what are the results?

Overall, both the long and short positions have been more profitable, with the average profit being 23.5%, and the average loss being 13.7%.

Which companies have already reached target prices?

  • Chipotle Mexican Grill (NYSE:CMG)

Chipotle Mexican Grill is the stock that most quickly reached its target price, which was set at $285.30 on July 17, 2012, when the stock was trading at $398.91. Several days later, after it reported earnings, the stock went down below $300.

Since it is trading around $310, bouncing above my price target, I recommend investors who went short to cover their positions at a gain of around 22.3% if they have not done it already at a lower price. The "optimistic scenario" suggests a price range of around $417 is achievable, which can get short positions into trouble.

  • John Deere (NYSE:DE)

John Deere is another stock that has reached my price target, which was set at $87.38 in June 15th, 2012, and closed December 31st at $86.42, currently trading around the $95 area.

I recommend investors who went long the stock at $74.08, the price when it was published, to take their 28.3% gain and sell, or keep very tight stops around the $95 level. Wait for a 5% pullback to keep building on your position, as current prices are no longer justified by valuation fundamentals.

  • Caterpillar (NYSE:CAT)

Caterpillar´s target price was set at $98.77 on June 15th, 2012, and the stock closed December 31st, 2012 at $86.42, and is currently trading around the $98 area.

I recommend investors who bought the stock at the price of $84.89, when the article was published, to take their 16.2% gain or place tight stops below the $97.50 level.

AGCO is another company that has reached its price target, set at $45.19 on June 20th, 2012, and is currently trading around the $54 area, and I recommend investors to take their 27.2% gain if they went long at the time the article was published, when AGCO was trading at $42.44.

Which stocks have failed to respond?

Apple has a price target of $675.12, set on July 12th, 2012, when the stock was trading at around $605, but eroding margins, competition and profit-taking has taken this stock to bargain levels, currently trading around $458.

The "negative scenario" included in my article includes a 5% sales growth per year and a gross margin drop to 35%, mainly driven by competition and its new products having eroded margins, which is currently happening.

If you believe, as I do, that Apple can grow revenues at higher than 5% and have gross margins at or above 35%, I do recommend you aggressively buy these shares, as the "negative scenario" has a price target of $480.75. There is little downside ahead for this company this year, the time to buy Apple is now. If you believe this stock will not recover, you can close your position at a 13.9% loss

  • Microsoft (NASDAQ:MSFT)

Microsoft has a target price of $34.95, given on July 7th, 2012, when the stock was trading at around $29.74. Microsoft is currently trading around $28 per share, so a 6.2% loss is unrealized by investors who went long at that price.

The "negative scenario" suggests a target price of $24, and the "business as usual" scenario suggests a target price of $30.91.

Since the Windows 8 has so far been received with indifference, I do recommend investors to either sell now at a loss or wait for this stock to reach around $30 and then sell, if you really believe in this company. I would sell at a 5.8% loss because of its slow reaction to overall price increases.

  • Sodastream (NASDAQ:SODA)

Sodastream received a $30.83 target price on August 1st, 2012, when the stock was trading around $41.31. Investors who went short this stock should wait for the price to drop to reality to cover their short positions, as it is now trading above $50, surpassing its $46 price target under the "optimistic scenario".

Investors who went long at the price on the date the article was published are encouraged to take their 23% gain and wait for better entry prices.

  • Coinstar (NASDAQ:CSTR)

Coinstar received a target price of $72.43 on July 26th, when the stock was trading around $59.22.

The fact that the stock is now trading around the $52 level makes me realize that the competition by other streaming companies was undermined, as the stock is now currently trading between the "negative scenario", which has a $42.26 target price, and the "business as usual" target price of $63.50.

I would recommend investors to sell this stock at a loss of around 11% unless you really believe the company´s share price will soon rise, but with the S&P trading above 1,500, I would not get greedy and wait for it to respond to positive catalysts. It´s better to take an early loss than to let it grow bigger, and I do believe it will be the case of this stock this year.

  • Amazon (NASDAQ:AMZN)

Amazon was assigned a $164.88 target price on July 23rd, 2012, when the stock was trading at $226. Many have argued that this stock is manipulated and its valuation is unjustified, and are tired of fighting the market. For those investors, I suggest you close your short trade at a loss of 15%.

I will not do it, as I do believe there are many cases of stocks that have fallen in a very short period of time. I do realize the market can stay irrational longer than any of us can stay solvent, but this is one of the trades that can have a big payoff when reality finally sets in.

Conclusion: Fundamentals triumph. Close all positions except Apple long and Amazon short

With the currently results, assuming you bought (or shorted, depending on the valuation) $10,000 worth of each stock, (worth $90,000 if you had done nothing) would now be worth $92,530. A 3% return if you close all of your positions right now. I think it would be a terrible idea to close all these positions right now, especially given the hit Apple´s stock has taken and the fact that Amazon is not worth a buck above $215.

Recommendation: Only close the positions that have reached or surpassed target prices, book the gains and hold onto the Apple long and the Amazon short (which is a great pair trade idea by the way), you could have a realized gain of 7.7% in 6 months tomorrow, and the remaining losses, I believe, should be made up by the market reacting to reality by:

  1. Apple´s price rising
  2. Amazon´s share price falling
  3. A combination of both

The possibility of Apple continuing to fall and Amazon continuing to rise is worth the risk/reward to me.

Recently, I have performed DCF valuations for Salesforce (NYSE:CRM), Fomento Mexicano (NYSE:FMX) and Research in Motion (RIMM).

Those results will be clearer as the year progresses. Currently, it seems the Blackberry 10 devices have been a disappointment, a "sell-the-news" event, and while it is too early to tell, I do believe the company has seen its best years.

If you have any comments, please use the comment section below.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Short AMZN calls, long FMX, short RIMM calls, among others not included in the article.