Disclaimer: I am just sharing my information, not suggesting you to buy any stocks or investments. Use the info here at your own risk. Please make your own judgements when making investment decisions.
In my last blog post on how to evaluate a stock, I listed three methods when valuing a stock:
- P/E Multiple method
- DCF model
- Return on equity valuation method
Today I am going to deep dive into the third method: Return on equity valuation method.
We use Ciena (NYSE:CIEN) as an example. We’ll answer this question, is CIEN current price $44.28 over valued? Can I buy CIEN at this price?
Return on equity valuation method
Warren Buffet’s favorate metric of profitability is Return on equity (ROE).
In its simple terms, it is Net income / shareholder’s equity.
In general, 15% ROE or higher is good.
Let’s deep dive in, and see if CIEN is overvalued.
All new data inputs specific to this Return on equity (ROE) valuation method:
a. Return on equity, of the last 5 years
CIEN Return on Equity %:
| 2015-10 | 2016-10 | 2017-10 | 2018-10 | 2019-10 |
|---|
| 4.23 | 10.46 | 86.95 | -16.96 | 12.36 |
(Source: https://financials.morningstar.com/ratios/r.html?t=0P0000019J&culture=en&platform=sal)
(4.23+10.46 +86.95-16.96+12.36)/5=19.408
This results in Return on Equity % of 19.408% for the last 5 years.
b. Shareholders’ Equity
From Balance Sheet, the shareholders’ equity in the latest quarter (Q2 2020 at the time of this writing) is: 2.24 billion.
c. Dividend Rate
No devidend.
Dividend Payout Ratio: 0.00%
https://finance.yahoo.com/quote/CIEN/key-statistics?p=CIEN
Also accoding to Nasdaq, “Dividend History information is presently unavailable for this company.” (Source: https://www.nasdaq.com/market-activity/stocks/cien/dividend-history)
Other inputs:
a. Shares Outstanding 153.64M
b. Expected growth rate: Next 5 Years (per annum) 8.90%
This is the rate CIEN is expected to grow its profit in the next 5 years.
However, as we pointed out in a related blog post using PE Multiple Method, forecast is skeptical, especially Wall Street tends to provide higher estimate than in reality. So let’s apply some discount such as 25% as our margin of safety.
so 8.90%*(1-0.25)=0.06675
so let’s give it 6.67%, being conservative.
c. Discount rate: 9%, used to calculate NPV or intrinsic value.
Now let’s calculate is intrinsic value based on ROE model.
Shareholder equity per share: 2.24 billion/153.64 Million=$14.579536579
Let it grow at a conservative growth rate 6.67% (with margin of safety 25%).
In Year 1, CIEN has Shareholder equity per share $14.579536579.
In Year 10, it will be 14.579536579*(1+6.67%)^9=$26.0690002156.
Year 10 net income is the income per share which the shareholder equity in Year 10 can generate: 26.0690002156*19.408%=$5.05947156184
The required value is the amount of shareholders’ equity that is required if company just earns the average historical stock market return of 9%: 5.05947156184/9%=$56.2163506871.
This is the shareholders’ equity in Year 10. To calculate its worth today, we will apply discount rate 9% as NPV:
56.2163506871/((1+9%)^10)=$23.7463940545
If CIEN has dividends, we would have added to it the sum of the 10 years of discounted dividends.
This gives us an intrinsic value estimate for CIEN: $23.7463940545.
The current share price $44.28 of CIEN as of Friday 9/5/2020 is very much overvalued, in my opinion.
By the way, Ciena price target lowered to $37 from $53 at Barclays. Reiterate Underweight.
Barclay’s analyst Tim Long lowered the firms price target on Ciena to $37 from $53 and keeps an Underweight weight rating on the shares. The company’s fiscal Q3 beat on sales, margin, and earnings; but guidance surprised to the downside.