The Good And Bad: Nokia Corporation & Dycom Industries

March Performance Recap

The Most Attractive Stocks (-4.1%) underperformed the S&P 500 (+5.0%) from March 3, 2022 through April 4, 2022 by 9.1%. The best performing large cap stock gained 21% and the best performing small cap stock was up 23%. Overall, 6 out of the 20 Most Attractive stocks outperformed the S&P 500.

The Most Dangerous Stocks (+1.8%) outperformed the S&P 500 (+5.0%) as a short portfolio from March 3, 2022 through April 4, 2022 by 3.2%. The best performing large cap short stock fell by 11%, and the best performing small cap short stock fell by 13%. Overall, 12 out of the 19 Most Dangerous stocks outperformed the S&P 500 as shorts.

The Most Attractive/Most Dangerous Model Portfolios underperformed as an equal-weighted long/short portfolio by 3.0%.

The Most Attractive stocks all share a high and rising return on invested capital (ROIC) and low price to economic book value ratio. Most Dangerous stocks have misleading earnings and long growth appreciation periods implied by their market valuations.

Most Attractive Stocks Feature for April: Nokia Corporation

Nokia Corporation (NOK) is the featured stock from April’s Most Attractive Stocks Model Portfolio.

Nokia has grown revenue by 5% compounded annually and net operating profit after-tax (NOPAT) by 12% compounded annually since 2013. More recently, the company’s NOPAT margin increased from 4% in 2018 to 7% in 2021, while invested capital turns rose from 1.2 to 1.6 over the same time. Rising NOPAT margins and invested capital turns drove Nokia’s ROIC from 4% in 2018 to 11% in 2021.

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Figure 1: Revenue & NOPAT Since 2013

Nokia Is Undervalued

At its current price of $5/share, NOK has a price-to-economic book value (PEBV) ratio of 0.6. This ratio means the market expects Nokia’s NOPAT to permanently decline by 40%. This expectation seems overly pessimistic for a company that has grown NOPAT by 6% compounded annually since 2015.

Even if Nokia’s NOPAT margin falls to 6% (equal to three-year average, compared to 7% in 2021) and the company’s NOPAT declines by less than 1% compounded annually for the next decade, the stock is worth ~$7/share today – a 40% upside. See the math behind this reverse DCF scenario. Should Nokia grow profits more in line with historical levels, the stock has even more upside.

Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology

Below are specifics on the adjustments I make based on Robo-Analyst findings in Nokia’s 20-F:

Income Statement: I made $1.8 billion in adjustments, with a net effect of removing $105 million in non-operating income (<1% of revenue).

Balance Sheet: I made $27.8 billion in adjustments to calculate invested capital with a net decrease of $14.6 billion. One of the most notable adjustments was $5.2 billion in other comprehensive income. This adjustment represented 17% of reported net assets.

Valuation: I made $21.8 billion of adjustments with a net effect of increasing shareholder value by $8.2 billion. Apart from total debt, one of the most notable adjustments to shareholder value was $10.1 billion in excess cash. This adjustment represents 34% of Nokia’s market cap.

Most Dangerous Stocks Feature: Dycom Industries, Inc.

Dycom Industries, Inc. (DY) is the featured stock from April’s Most Dangerous Stocks Model Portfolio.

Dycom’s economic earnings, the true cash flows of the business, fell from $15 million in fiscal 2016 (FYE is 1/29/22) to -$93 million in fiscal 2022. The company’s NOPAT margin fell from 6% to 2%, while invested capital turns fell from 1.6 to 1.5 over the same time. Falling NOPAT margins and invested capital turns drove Dycom’s ROIC from 9% in fiscal 2016 to 3% in fiscal 2022.

Figure 2: Economic Earnings Since Fiscal 2016

Dycom Provides Poor Risk/Reward

Despite its poor fundamentals, Dycom is priced for significant profit growth, and I believe the stock is overvalued.

To justify its current price of $95/share, Dycom must improve its NOPAT margin to 4% (10-year average, compared to 2% in fiscal 2022) and grow revenue by 11% compounded annually for the next decade. See the math behind this reverse DCF scenario. In this scenario, Dycom grows NOPAT by 18% compounded annually over the next ten years. Given that Dycom’s NOPAT fell 16% compounded annually over the past five years, I think these expectations are overly optimistic.

Even if Dycom can achieve a NOPAT margin of 3% (three-year high) and grow revenue by 8% compounded annually for the next decade, the stock is worth just $42/share today – a 55% downside to the current stock price. See the math behind this reverse DCF scenario. Should Dycom’s revenue grow at a slower rate, the stock has even more downside.

Each of these scenarios also assumes Dycom can grow revenue, NOPAT, and FCF without increasing working capital or fixed assets. This assumption is unlikely but allows me to create truly best-case scenarios that demonstrate how high expectations embedded in the current valuation are.

Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology

Below are specifics on the adjustments I make based on Robo-Analyst findings in Dycom’s 10-K:

Income Statement: I made $56 million in adjustments, with a net effect of removing $16 million in non-operating expenses (<1% of revenue).

Balance Sheet: I made $588 million in adjustments to calculate invested capital with a net increase of $257 million. One of the most notable adjustments was $226 million in asset write-downs. This adjustment represented 13% of reported net assets.

Valuation: I made $1.1 billion in adjustments, with a net decrease to shareholder value of $816 million. Apart from total debt, the most notable adjustment to shareholder value was $154 million in excess cash. This adjustment represents 6% of Dycom’s market cap.

Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.

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