3 Technology Stocks To Buy, 3 To Sell, 1 To Hold

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Includes: AAPL, CRM, FFIV, FTR, HPQ, INTC, VMW
by: Efsinvestment

Earnings season is back, and this is a great time to be in the market. As I expected, the markets are in a strong recovery mood. There are still several issues within the Eurozone, but these issues have already been priced by the market. Since equities made significant losses in the last quarter, I am expecting a swift rally in this quarter. The one-week performance of equities is remarkable. Basic materials gained the most (8.6%), followed by industrials (7.1%) and technology companies (7.0%).

Tech companies are highly diversified. While the technology titans trade at substantial discounts, the relatively smaller tech stocks are trading at a pretty high premium. Choosing the best stock in this environment remains a challenge. There are several way to determine the fair value of a company. I have been using discounted earnings model to estimate the intrinsic value of stocks. So far, the model worked pretty well in distinguishing fairly-valued stocks from irrationally exuberant ones. Here is a brief review of the model:

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 estimates. You can set these parameters as you wish, according to your own diligence. Applying this model to selected technology stocks resulted in the following trade ideas:

Company

Fair Value Range

My Take

Apple (AAPL)

$569

$643

Buy

Intel (INTC)

$35.42

$44.63

Buy

Hewlett Packard (HPQ)

$64.39

$83.78

Buy

F5 Networks (FFIV)

$69.45

$83.88

Sell

Salesforce.com (CRM)

$22.91

$33.37

Sell

VMware Inc. (VMW)

$45.10

$55.30

Sell

Frontier Communications (FTR)

$2.67

$7.61

Hold

(You can download FED + Fair Value Estimator, here.)


Apple has been one of the best companies in the world. Thanks to Steve Jobs' [rip] visionary innovations, the company returned tremendous profits to its shareholders. It will be impossible to replace someone as Steve Jobs, but I expect Tim Cook to keep the company on the right track.

The stock is trading with a trailing twelve month [ttm] EPS of $25.26, and forward EPS estimate of $32.66. The book value per share is $74.81. Based on 18.40% annualized EPS growth estimate, my FED+ fair value range for Apple is $568 - $643. As of October 14, Apple was trading at $422, which is around $150 below the lower boundary of fair value range. Analysts are also bullish on Apple. Their mean target price estimate is $490. Hudson Square, Barclays, and Deutsche Bank have target prices of $700, $555, and $530, respectively

Intel, the glorious winner of the microchip battle, is one of the cheapest stocks in the market. The stock is trading with a ttm EPS of $2.18, and forward EPS estimate of $2.43. The book value per share is $9.21. Based on 11.5% annualized EPS growth estimate, my FED + fair value range for Intel is $35.42 - $44.63. As of October 14, Intel was trading at $23.50, which is around $12 below the lower boundary of fair value range. The stock offers a yield of 3.57%. RBC Capital has an outperform rating with a target price of $28.

Hewlett Packard took a big hit over the last few months. The stock was subject to several downgrades. The panic sell-offs drive the stock all the way down to a crazy-low P/E ratio of 6.13. The stock is trading with a ttm EPS of $4.26, and forward EPS estimate of $4.75. The book value per share is $19.39. Based on 9.5% annualized EPS growth estimate, my FED+ fair value range is $64 - $84. As of October 14, HPQ was trading at $26.11, which is way below the lower boundary of ($64) its fair value range. Although the street is pretty bearish on the stock, I think the stock is in oversold territory. From a technical perspective, it has already double-bottomed. I do not think there is any downside potential left. HPQ offers a great value for contrarian investors.

F5 Networks is trading with a ttm EPS of $2.72, and forward EPS estimate of $4.30. The book value per share is $14.43. Based on 18.60% annualized EPS growth estimate, my FED + fair value range for the F5 Networks is $69.45 - $83.88. As of October 12, the stock was trading at $90.07, which is above the upper boundary of its fair value range. At the current price, I rate F5 Networks as a sell. Although the company has shown great performance over the past five years, the higher expectation are already priced by the market. EPS has to grow by 30% annually to justify its trailing P/E ratio of 32.28.

Salesforce.com is trading with a ttm EPS of $0.2, and a forward EPS estimate of $1.78. The book value per share is $10.46. Based on 23.10% annualized EPS growth estimate, my FED + fair value range for the Salesforce.com is $22.91 - $33.37. As of October 14, the stock was trading at $131.80, which is way above the upper boundary of its fair value range. Trailing P/E ratio is 636.30, forward P/E ratio is 71.49. P/B ratio of 12.17 and PEG ratio of 23.57 are strong red flags. I think Salesforce.com is the hot potato of the market. At some point the stock will implode. It can be a good short candidate.

VMware Inc. is trading with a ttm EPS of $1.28, and a forward EPS estimate of $2.46. The book value per share is $10.20. Based on 24.30% annualized EPS growth estimate, my FED + fair value range for VMware is $45.10 - $55.30. As of October 14, the stock was trading at $93.08, which is also way above the upper boundary of its fair value range. Trailing P/E ratio of 72.72, PEG ratio of 2.79, and P/S ratio of 11.86 are strong red flags. I rate VMware as a sell.

Frontier Communications is trading with a ttm EPS of $0.16, and a forward EPS estimate of $0.37. The book value per share is $4.94. Based on 0.00% annualized EPS growth estimate (Morningstar suggested that number), my FED + fair value range for the Frontier Communications is $2.67 - $7.61. As of October 14, the stock was trading at $5.97, which is within the middle of its fair value range. The stock lost 20.87% in the last quarter, and the long-term trend is still downward. However, it is too late to sell. I rate Frontier as a hold.

Disclosure: I am long AAPL, INTC.