The stock is not anywhere near as cheap as the free cash flow suggests, but it’s also not as expensive as the net income suggests. For a company which saw just 1.6% revenue growth and a decline in earnings in 2013 the price isn’t all that attractive. Analysts expect earnings growth of 13% annually over the next five years, and if that pans out then the stock is reasonably priced. But analysts are often wrong.
Other deceptive tech stocks
Competitor EMC Corporation (NYSE:EMC) shows the same large discrepancy between net income and free cash flow, partially due to $895 million in stock-based compensation which negates much of its buyback effort. While the company has spent a total of $5.1 billion on buybacks over the past 3 years, 10% of the current market capitalization, the diluted share count has actually increased. All that buyback money should be counted as an expense, thus greatly reducing the company’s profits. Just like in the case of NetApp Inc. (NASDAQ:NTAP), looking at just the free cash flow makes EMC Corporation (NYSE:EMC)’s stock seem much cheaper than it really is.
Another company with a history of substantial stock-based compensation is networking giant Cisco Systems, Inc. (NASDAQ:CSCO). Cisco Systems, Inc. (NASDAQ:CSCO) buys back a tremendous number of shares, and has been doing so for years, but stock-based compensation limits the impact of the buyback program. Compared to NetApp and EMC Corporation (NYSE:EMC) Cisco Systems, Inc. (NASDAQ:CSCO)’s stock-based compensation is fairly tame. In the last fiscal year Cisco Systems, Inc. (NASDAQ:CSCO)’s stock-based compensation represented 12% of the operating cash flow. This compares to NetApp Inc. (NASDAQ:NTAP)’s 20% and EMC Corporation (NYSE:EMC)’s 14%. NetApp is actually the worst offender based on this percentage. Even after excluding the stock-based compensation Cisco Systems, Inc. (NASDAQ:CSCO) is still fairly cheap, especially considering it has a mountain of cash on its balance sheet.
The bottom line
When you’re determining the valuation of a stock it’s important to look at it from all angles. Simply looking at the net income or the free cash flow isn’t enough, as both numbers can be skewed, and the balance sheet shouldn’t be forgotten. NetApp Inc. (NASDAQ:NTAP)’s buyback program is ineffective, basically completely canceled out by stock-based compensation, and not including that cost in your analysis will lead to inflated results. When a company touts non-GAAP figures they’re likely trying to get you to forget about stock-based compensation. Don’t let them succeed.
Timothy Green owns shares of Cisco. The Motley Fool recommends Cisco Systems (NASDAQ:CSCO). The Motley Fool owns shares of EMC. Timothy is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article Cover All The Bases When Valuing Stocks originally appeared on Fool.com is written by Timothy Green.
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