Is Polycom's Stock Expensive or Cheap by the Numbers?

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Numbers can lie -- but they're the best first step in determining whether a stock is a buy. In this series, we use some carefully chosen metrics to size up a stock's true value based on the following clues:

  • The current price multiples.
  • The consistency of past earnings and cash flow.
  • How much growth we can expect.

Let's see what those numbers can tell us about how expensive or cheap Polycom (NAS: PLCM) might be.

The current price multiples
First, we'll look at most investors' favorite metric: the P/E ratio. It divides the company's share price by its earnings per share (EPS) -- the lower, the better.

Then, we'll take things up a notch with a more advanced metric: enterprise value to unlevered free cash flow. This divides the company's enterprise value (basically, its market cap plus its debt, minus its cash) by its unlevered free cash flow (its free cash flow, adding back the interest payments on its debt). Like the P/E, the lower this number is, the better.

Analysts argue about which is more important -- earnings or cash flow. Who cares? A good buy ideally has low multiples on both.

Polycom has a P/E ratio of 24.6 and an EV/FCF ratio of 15.5 over the trailing 12 months. If we stretch and compare current valuations to the five-year averages for earnings and free cash flow, Polycom has a P/E ratio of 39.9 and a five-year EV/FCF ratio of 19.5.

A positive one-year ratio under 10 for both metrics is ideal (at least in my opinion). For a five-year metric, under 20 is ideal.

Polycom has a mixed performance in hitting the ideal targets, but let's see how it compares against some competitors and industry mates. 

Polycom24.615.539.919.5
Cisco Systems (NAS: CSCO) 16.17.414.27.8
Hewlett-Packard (NYS: HPQ) 8.09.57.28.8
Radvision (NAS: RVSN) NMNMNM107.8

Source: S&P Capital IQ; NM = not meaningful due to losses.

Numerically, we've seen how Polycom's valuation rates on both an absolute and relative basis. Next, let's examine...

The consistency of past earnings and cash flow
An ideal company will be consistently strong in its earnings and cash flow generation.

In the past five years, Polycom's net income margin has ranged from 4.2% to 8.4%. In that same time frame, unlevered free cash flow margin has ranged from 9.3% to 13.1%.

How do those figures compare with those of the company's peers? See for yourself:

anImage

Source: S&P Capital IQ; margin ranges are combined.

Additionally, over the last five years, Polycom has tallied up five years of positive earnings and five years of positive free cash flow.

Next, let's figure out...

How much growth we can expect
Analysts tend to comically overstate their five-year growth estimates. If you accept them at face value, you willoverpay for stocks. But while you should definitely take the analysts' prognostications with a grain of salt, they can still provide a useful starting point when compared to similar numbers from a company's closest rivals.

Let's start by seeing what this company's done over the past five years. In that time period, Polycom has put up past EPS growth rates of 16.4%. Meanwhile, Wall Street's analysts expect future growth rates of 19.5%.

Here's how Polycom compares to its peers for trailing five-year growth (due to losses, Radvision's trailing growth rate isn't meaningful):

anImage

Source: S&P Capital IQ; EPS growth shown.

And here's how it measures up with regard to the growth analysts expect over the next five years (Note: My data provider doesn't list any estimates for Radvision, but Yahoo! Finance lists 18%):

anImage

Source: S&P Capital IQ; estimates for EPS growth.

The bottom line
The pile of numbers we've plowed through has shown us the price multiples shares of Polycom are trading at, the volatility of its operational performance, and what kind of growth profile it has -- both on an absolute and a relative basis.

The more consistent a company's performance has been and the more growth we can expect, the more we should be willing to pay. We've gone well beyond looking at a 24.6 P/E ratio and we see that Polycom's EV/FCF multiples are a bit cheaper than its P/E multiples. We also see solid margins and profitability along with strong five-year growth.

Overall, the initial numbers show a company trading in the reasonable-to-cheap range with solid operational metrics. But this is just a start. Remember, the numbers can lie. If you find Polycom's numbers or story compelling, don't stop. Continue your due diligence process until you're confident one way or the other. As a start, add it to My Watchlist to find all of our Foolish analysis.

To see the stocks that I've researched beyond the initial numbers and bought in my public real-money portfolio, click here.

At the time this article was published Anand Chokkaveluowns shares of Cisco.The Fool owns shares of and has created a bull call spread position on Cisco Systems.Motley Fool newsletter serviceshave recommended buying shares of Cisco Systems and Polycom. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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