After seven straight quarters of pummeling the prognostications of professional pundits, Polycom (NASDAQ:PLCM) stock plummeted when it warned that it might possibly "miss" its earnings estimate when reporting quarterly results tomorrow afternoon.

What analysts say:

  • Buy, sell, or waffle? Twelve analysts follow Polycom. Seven rate it a buy, four a hold, and one a sell.
  • Revenue. On average, they're looking for 39% sales growth, to $240.1 million.
  • Earnings. Pro forma profits are predicted to be up 26%, to $0.34 per share.

What management says:
You can read all about the earnings warning by clicking here. To sum up, Wall Street had been expecting Polycom to earn $0.35 per share pro forma. (That's Latin for "once you add back in all the stuff that costs money.") To beat that number and continue its winning streak, the company would have had to earn $0.36. But Polycom didn't think that was doable, so on Oct. 2, management issued guidance for a range of $0.33 to $0.35 per share pro forma -- and for $0.19 to $0.21 under GAAP.

What management does:
Now, Polycom pushers will argue that even with the earnings warning, the company is still looking at 26% profits growth -- superb by any measure. To that, I'd reply: "Any measure but one."

Relative to sales growth, profits growth appears pretty puny, because profit margins earned on Polycom's rapidly growing revenue are shrinking. In each of the last two quarters, each of the rolling gross, operating, and net margins has slipped.

Polycom is still earning operating margins superior to those of rivals Avaya (NYSE:AV) and 3Com (NASDAQ:COMS), but it's miles away from the 25% margins that Cisco (NASDAQ:CSCO) generates.

Margins

3/06

6/06

9/06

12/06

3/07

6/07

Gross

61.9%

61.7%

61.5%

61.6%

61.4%

60.7%

Operating

13.6%

12.9%

12.5%

12.5%

12.4%

11.7%

Net

10%

8.9%

8.5%

10.5%

9.5%

8%
All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
Much as I'd like to give you the latest thoughts on Polycom from our Motley Fool Rule Breakers team, the three-year anniversary issue of the newsletter just came out a few weeks ago. Subscribers get dibs on the contents, and we're not supposed to release that for 30 days after publication. (Of course, you can get around that restriction by signing up for a free trial of the service.)

Meanwhile, here's my own view of the stock. At 37 times trailing earnings, and with analysts predicting only 20%-per-year profits growth over the next five years, Polycom looks like anything but a bargain -- at first glance. But look a little deeper, and you'll see that this company is generating free cash flow at nearly twice the rate of its GAAP earnings. Trailing free cash flow sits well beyond $100 million, giving the firm a price-to-free cash flow ratio of approximately 21. At this price, I'm a buyer.