Nokia (NYSE: NOK) shares were up almost 12% in 2003, and for investors who held tight as the stock underperformed the market, the first few weeks of 2004 were like vindication, rewarding them for their patience with a 24% gain.
(Note: In the following analysis, I've translated Nokia's 2003 results into U.S. dollars at the Dec. 31, 2003 exchange rate of $1.2552/1.0 euro.)
Expectations are high, and last week the company reported 2003 earnings per share of 0.75 euro ($0.94), up 6% over 2002. At $21.00 a share, Nokia sports a market cap of $98.7 billion, and trades for 22 times prior-year earnings. All of which makes me wonder if the stock isn't a bit overvalued following its recent runup.
I know better than to trust the P/E ratio as a final arbiter of value, and I prefer to use cash-based measures to determine value. My favorite method is the enterprise value-to-free cash flow (EV/FCF) analysis, because it brings in two important elements missed by the P/E ratio: cash flow and debt.
Nokia generated free cash flow of $6 billion in 2003, up 7.1%, and finished the year with $14.2 billion in cash and equivalents. That's $1.28 and $3.02 per share, respectively. Total short- and long-term interest-bearing debt was $616 million, or $0.13 per share, for a debt-to-equity ratio of 0.04. Crunching the numbers gives us an enterprise value of $85.1 billion, or $18.11 per share. This puts Nokia's enterprise value at around 14.1 times free cash flow.
Running through the same process with one of Nokia's largest competitors, Motorola (NYSE: MOT), gives us a reasonable comparison. Motorola's 2003 financial statements list short- and long-term debt of $7.6 billion, cash and equivalents of $7.9 billion, and $2.1 billion in free cash flow. At $17 per share, its enterprise value of $39.3 billion is 18.7 times 2003 free cash flow.
The conclusion? It appears Nokia represents better value than its closest competitor, with a much stronger balance sheet and a sizable market share lead that's expected to increase again this year. However, with an EV/FCF multiple twice the free cash growth rate, management has to get cash flow growing faster if it hopes to see higher stock prices.
Chris Mallon owns shares of Nokia through his private investment partnership. He's patiently waiting for your email
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