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RIMM, AAPL And GOOG: Are They Really Overvalued? The Answer May Surprise You

July 6, 2008 1:40 PM

perplexed.jpgI have been looking into RIMM, AAPL and GOOG lately to see if they are truly “grossly” overvalued. I assumed all three were before looking at the data, and the answer is not as clear as one may think. The answer is yes, and no. If the economy holds up then RIMM is possibly undervalued, for instance. But will the economy hold up? That is the thing we do not know for certain. My personal view has long been no.

 RIMM’s PE is high at 42, but the forward PE is less bubble like at 30. More importantly, according to SmartMoney.com, the PEG ratio is .81. If you recall, Peter Lynch’s mantra was that the true value of a stock was a PEG ratio of 1.00. Therefore, if you believe in his reasoning, then RIMM is undervalued at $115, believe it or not, by a whopping 20%. It would be considered a VALUE stock using his valuation methodology at this price.

This is why I have long cautioned against trading based upon “valuation”. RIMM could easily go to $90 here, or it could reverse and go over $150 just as easily. Which value is correct? The answer is that either is correct if that’s what the market says it is worth.

Let’s look at another “high flier”, AAPL. SmartMoney estimates AAPL’s PEG at 1.44. Therefore, according to the same valuation theory, AAPL is overvalued by over 40%. Should AAPL be shorted based upon this metric? Absolutely NOT. It was trading at a PEG of near 3.00 last year. Shorting on valuation is not only dangerous, it is begging for bankruptcy. Wait for a signal to short stocks that appear overvalued, not blind short them. On the other side, should RIMM be long here because of the low PEG? Absolutely NOT. It could go far lower. Wait for the market to signal a bottom.

Another stock that always “seems” overvalued is GOOG. Looking into the numbers of GOOG, it has a PEG of 1.03. That surprised me as I have always “assumed” it seemed pricey.

Point being, the market can trade stocks at PEG ratios of .75, 1.5 or even 3.00. There is a HUGE difference between these numbers, rather obviously. If RIMM had the same PEG as AAPL it would be about $180 currently. Is the stock worth $90 or $180? I have no idea. It is worth what the market says it’s worth. In addition, if RIMM had the same peak valuation as AAPL, it would be well over $200. Blind shorting these stocks is very dangerous because of this possibility. If you want to be short them, wait for signals.

On the other side of that, I would personally never buy a stock just based upon the PEG. The reason for this is that analysts tend to extrapolate data into the “forever”. Huge earnings growth rates never last forever, but the PEG ratios always assume they will. Look at PEG for indications, but also, and more importantly, look at what the market is telling you. The market will decide the value of a stock, each and every time. Like it or not.

PEG Caveat: In this economy you cannot rely on PEG ratios, PE’s or any valuation mechanisms. The reason for this is if we enter a severe recession, all numbers are inflated. PEG assumes growth rates will continue. PE’s assume earnings will not fall. If we enter a severe recession, obviously both growth rates and earnings will fall. The big question is how bad a recession and how long.

Lastly, if you want to simply make decisions on so called “valuation” you are on the wrong site. I make calls on 3 day trades, not long term investing. I do make fundamental calls when I am reasonably certain the market is wrong, but in general, my calls are trades, not 5 year investments. I cannot predict 5 years down the road.

Written by Tom@StockBlade.com · Filed Under AAPL, GOOG 

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