Earlier this month I wrote about the prospect that Nokia (NYSE:NOK), the Finnish telecom company, will pay a dividend at the end of the year. Based on those projections, I put the value of NOK stock at $6.63 per share.
In this article, I’ll show how Nokia’s own free cash flow (FCF) guidance leads to just about the same price target (in fact, a little higher). This means that NOK stock, which closed at $5.36 on June 29, is worth at least 25% more.
It is actually very simple to come up with this conclusion. The reason is Nokia gave very concrete guidance on page 2 of its most recent earnings release on April 29. Here is how those projections work out.
Free Cash Flow Projections
The basic guidance on free cash flow from Nokia can be worked out from the following specific guidance:
“In full year 2021, Nokia expects the free cash flow performance of Nokia Technologies to be approximately EUR 600 million lower than its operating profit, primarily due to prepayments we received from certain licensees;”
So to determine the company’s 2021 FCF all we have to do is estimate its operating profit and then subtract EUR 600 million. Luckily, Nokia also provided guidance about operating profit. It provided a table that indicated the operating margin would be between 7% and 10%. In addition, sales for 2021 are forecast by Nokia to be between EUR 20.6 billion to EUR 21.8 billion.
So using these numbers, here is how we can estimate FCF. First, let’s assume that sales will be at the midpoint, or EUR 21.2 billion. At $1.19 per EUR, that works out to $25.228 billion. Then, we take 8.5% of that (i.e., the midpoint between 7% and 10% operating margin), to derive $2.144 billion in forecast operating profit.
Next, we subtract $714 million (i.e. EUR 600 million x $1.19) from operating profits of $2.144. The result: $1.430 billion in FCF for 2021.
If we use a 10% margin and apply it to the upper end of sales (EUR 21.9 billion), the FCF figure works out to $1.994 billion. So FCF will be somewhere between $1.43 billion and $1.994 billion. We can use that to estimate the value of NOK stock.
What Nokia Is Worth
For simplicity’s sake, let’s conservatively assume that FCF will be between $1.5 billion and $1.6 billion, or $1.55 billion. Now if we use a 4.0% FCF yield metric, we can estimate the value of Nokia stock.
So dividing $1.55 billion by 4.0% results in a target market capitalization of $38.75 billion. This is 25.73% more than the market cap of $30.82 billion as of June 29. In other words, NOK stock is worth 25.73% more, or $6.74 per share.
Note that this is very close to my original estimate of $6.63 per share, based on a projected 4.75% dividend yield. That yield was determined as the midpoint between Intel (NASDAQ:INTC) and AT&T (NYSE:T).
So now we have two different economic models to determine the value of NOK stock. Both of them project that it is worth about 25% more.
What To Do With NOK Stock
My projected target value is higher than Wall Street analyst predictions. For example, TipRanks reports that 11 analysts have an average target price of $5.84, or 9% above today’s price. This is similar to what Seeking Alpha projects as well. Their survey of 12 analysts shows that the average price target is $5.40, close to the price on June 29 of $5.36.
Let’s say there is a 40% chance that analysts are right and a 50% chance I am right, with the remainder 10% with a market return (say 15%). Here is how that works out.
The total expected return will be 40% x 9%, or 3.6%, from the analysts’ estimate. Using my 25% expected return, at a 50% chance of it being right, the outcome is 12.5%. Finally, the 10% chance that the stock will earn a market return of 15% leaves an expected return of 1.5%.
So, adding up all three of these possibilities results in a total expected return of 17.6% (i.e., 3.6% +12.5%+1.5% = 17.6%). So the probability-weighted target price for NOK stock is $6.30 (i.e., $5.36 x 1.176). That is the result of 2 of my models (dividend and FCF based), analysts’ estimates, and a market return. That’s a pretty good return for most investors.
On the date of publication, Mark R. Hake did not own any security mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.