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Anyone who reads my daily sonar articles (here) knows I am an options investor all the way. I believe options can be a great supplement to traditional fundamental analysis to determine the sentiment or direction of a stock. Large hedge funds and investors alike use options to hedge existing positions and to make speculative bets and get leverage to the upside or downside. Today I'm mixing things up a bit, dedicating this article to both fundamental and options analysts to uncover some of the hottest potential undervalued and overvalued stocks.

First lets start with our competitors in terms of value plays from multiple sectors.

  • Apple Inc (NASDAQ:AAPL)
  • Walter Energy (NYSE:WLT)
  • Genworth Financial (NYSE:GNW)
  • DUSA Pharmaceuticals (NASDAQ:DUSA)
  • Southwest Airlines (NYSE:LUV)
  • Oasis Petroleum (NYSE:OAS)

If you turn on the TV it seems like every analyst is touting every stock in the world as cheap. Most investors know one of the most used metrics when it comes to a company's valuation is its P/E value or Price to Earnings ratio. However, sometimes an even better less known indicator is the PEG or Price to Earnings Growth. In this case, the lower the PEG ratio the "cheaper" the stock is in terms of earnings growth. A PEG ratio of over 2 is considered to be expensive for growth in my book where <1 is more value territory. When it comes to investments, growth is what people look for as growing revenues is typically not enough, but we'll address that later in the overvalued sections. For example, take a look at the table below comparing these stock valuations.

Stock

P/E Ratio

P/E Industry Avg.

PEG Ratio

PEG Industry Avg.

TTM EPS Growth

EPS Industry Avg.

Short %

AAPL

13.06

13.02

0.63

0.67

59.59%

43.58%

1.72%

WLT

9.43

12.29

0.73

1.40

-52.73%

-179.73%

10.32%

GNW

10.00

29.94

0.63

2.23

216.65%

-44.83%

2.52%

DUSA

19.13

23.84

0.58

12.51

209.90%

8.69%

4.72%

LUV

14.06

14.26

0.66

1.04

205.31%

6.24%

2.40%

OAS

19.47

21.28

0.73

2.14

450.77%

-366.79%

8.25%

As you can see, every single stock with the exception of AAPL has a P/E ratio below the industry average. However, if you listen to the all the analysts, they say AAPL is trading at ~11 P/E when you back out the cash. In my opinion, this isn't a valid way to evaluate a company because it is effectively the same as adding a company's net debt to the share price. The calculation is more relevant when evaluating the company's "Enterprise Value". Thus, the P/E value in my opinion must be taken at face value and not adjusted, regardless of what they say on TV. This is also a primary reason why I believe the PEG ratio is more valuable when evaluating stocks. Unfortunately, this is not useful if the company is not actually making money but that is a different article for another day. Sure, AAPL's almost $120B in cash is nice but it does not make the stock any cheaper in terms of an investment.

Now we all know earnings per share growth is nice, but it must be noted growing a 1B dollar business is much harder than a $1M. So now let's look at revenues of these companies over the last four years.

Stock

2008

2009

2010

2011

AAPL

37,491

42,905

65,225

108,249

WLT

1,150

967

1,588

2,571

GNW

9,948

9,069

10,089

10,368

DUSA

29,545

28,338

36,423

45,296

LUV

11,023

10,350

12,104

15,658

OAS

34,736

37,755

128,927

330,422

As you can see, with the exception of OAS, no one holds a candle to the revenue generated by AAPL. The harsh truth is global demand has seen some serious deterioration in fundamentals in the world markets. This affects all sectors and markets, as it appears every central bank in the world is in a race to devalue their currency to boost growth. Unfortunately, this does nothing when overall we are in a period of global demand destruction.

For example, the world of technology has been real soft over the last four to six weeks, and Friday's sell-off of tech favorite AAPL highlights this softness. Other sectors such as coal have been nothing but annihilated over the last 12 months with companies like WLT getting cut in half. With global demand putting pressure on equities combined with potential for several fiscal cliff events, the markets will continue to be difficult, at best, to traverse moving forward.

This again is the reason I turn to the options market to help me make decisions in terms of which direction a stock may go. For example earlier last week I wrote about bullish paper in TripAdvisor (NASDAQ:TRIP), which lead those who followed to large gains across the board. In addition, a bullish paper was seen in financials Goldman Sachs (NYSE:GS) and Bank of America (NYSE:BAC), and even the financial ETF (NYSEARCA:XLF), which also lead to large gains in the past couple of weeks. This leads us to our shootout stocks, and what the options markets say regarding these contenders. Below is a table of the net premium of these stocks over the last 2 months and first trading day of November. The net premium of options is all options bought on the ask minus those sold on the bid. What you have left is the net premium, which can be a very good indicator of where a stock is going to go. For example, as you can see below, the net premium of AAPL greatly shifted sentiment in October, which corresponded with lower prices.

Stock

Sept Call Pemium

Sept Put Premium

Oct Call Premium

Oct Put Premium

Nov Call Premium

Nov Put Premium

AAPL

24M

(8.2M)

(18.2M)

9.8M

(12M)

6M

WLT

200K

56K

356K

(45K)

68K

(66K)

GNW

12K

2K

60K

(30K)

(26K)

(5K)

DUSA

N/A

N/A

N/A

N/A

N/A

N/A

LUV

(15K)

12K

2K

(5K)

1K

6K

OAS

9K

60K

32K

(10K)

(1K)

(10K)

Ok so the real question is what does all of this really mean? AAPL had very clear options direction from Friday and it was down all the way. Others were mixed, with WLT being the most bullish. However, this is just one day where the numbers from September and October are the total deltas for the month. As you can see, in almost every case the options showed where the stock was headed. Please note DUSA does not trade enough options to calculate premium effectively.

So now lets wrap this up and declare a winner as to this list of stocks.

Stock

P/E

PEG

EPS Growth

Rev Growth

Analysts Estimates

Options Sentiment

AAPL

B-

B-

A+

A

A-

C

WLT

A-

A-

C

F

F+

B+

GNW

A

A

B-

C+

C+

C+

DUSA

B

A+

C+

B

D

N/A

LUV

B-

B+

B-

C

C

C

OAS

B

A

A-

A+

B+

B-

In conclusion, when taking into account all aspects of valuation, options sentiment, and analysts estimates I feel there is one winner. In my opinion Oasis Petroleum just narrowly edges out Apple to take the gold. Although I do believe both Walter and Genworth have considerable room to run to the upside, I must declare Genworth the victor in this list. Simply put, Walter has too many obstacles to overcome in terms of MET coal prices and global demand. However, my opinion could change quickly if Romney wins the presidential election.

The final undervalued results are ...

  • Gold: Oasis Petroleum
  • Silver: Apple
  • Bronze: Genworth Financial

Now let's look into the "Over" competitors in terms of value plays from multiple sectors.

  • Amazon (NASDAQ:AMZN)
  • Facebook (NASDAQ:FB)
  • Netflix (NASDAQ:NFLX)
  • Zillow (NASDAQ:Z)
  • Molycorp (NYSE:MCP)
  • Pharmacyclics (NASDAQ:PCYC)

Again first we will look at the valuations in terms of earnings and earnings growth.

Stock

P/E Ratio

P/E Industry Avg.

PEG Ratio

PEG Industry Avg.

TTM EPS Growth

EPS Industry Avg.

Short %

AMZN

3106.42

1903.78

87.75

54.23

-96.06%

-26.59%

2.33%

FB

196.88

52.73

7.57

2.56

-

22.66%

11.69%

NFLX

97.33

21.00

4.19

1.25

-82.06%

19.49%

29.87%

Z

326.17

91.43

5.06

13.96

243.54%

42.92%

43.87%

MCP

449.89

15.87

22.49

2.26

-103.53%

-49.48%

29.28%

PCYC

408.24

23.84

2551.50

12.51

123.98%

8.69%

8.00%

Compared to our earlier stocks, these stocks are in the stratosphere in terms of valuation. Every one of these stocks, with the exception of Z, having a lower PEG than its industry average screams these stocks are expensive. Again, as those who follow my articles know, I'm not a fan of NFLX or another long time hated stock of mine Research in Motion (RIMM). Therefore, I'll try to be as non-biased as possible, but look at the liabilities of these companies.

Stock

Liabilities 2008

Liabilities 2009

Liabilities 2010

Liabilities 2011

Liabilities 2012

AMZN

5,642M

8,556M

11,933M

17,521M

15,281M

FB

--

--

828M

1,432M

1,864M

NFLX

268M

481M

692M

2,426M

3,092M

Z

--

3.482M

6.565M

15.455M

22.367M

MCP

17M

23M

33M

410M

1,713M

PCYC

1.922M

20.042M

10.059M

14.678M

86.997M

In terms of stock equity, nothing will harm a stock more than loads of debt. Of course, it does appear AMZN defies this law as this stock could have grown at double digits for the next 10 years and still not justify the current stock price. Although both Z and PCYC have much less than $1B of liabilities, they also have much less revenue, so let's keep that in mind. Additionally, according to the NFLX 10Q, "5.0B of content liabilities due," which is the minimum NFLX will have to pay over the next year. Finally, back to the options pits to see what they are saying about where these stocks are heading.

Stock

Sept Call Premium

Sept Put Premium

Oct Call Premium

Oct Put Premium

Nov Call Premium

Nov Put Premium

AMZN

2M

3.5M

(6.1M)

4.2M

233K

607K

FB

1.05M

(800K)

1.2M

(4.8M)

102K

(258K)

NFLX

(650K)

(345K)

6.8M

800K

553K

(317K)

Z

120K

(32K)

(96K)

220K

14K

13K

MCP

(246K)

190K

(60K)

120K

(86K)

50K

PCYC

457K

380K

(623K)

320K

(156K)

60K

If you compare the net premiums as shown, the stocks did pretty much track the options activity over the last couple of months. The interesting options activity was the huge bullish paper in NFLX over the last 2 weeks. It appears the Icahn deal taking an activist stake in NFLX may not have been so concealed after all. Options players made millions on the NFLX move and continue to be to the upside. If the first day of November means anything, FB and NFLX could see a nice move in the near future. Whereas, both MCP and PCYC could be headed for some rough waters as calls have consistently been sold and puts purchased.

So now let's look at my final grades for these stocks

Stock

P/E

PEG

EPS Growth

Debt

Analysts Estimates

Options Sentiment

AMZN

D

D-

D

F

B+

C+

FB

C

C-

N/A

C-

C

B-

NFLX

C+

C+

C-

D+

C+

B+

Z

C-

C

A

C-

C-

C

MCP

F

D

F

D-

D

D-

PCYC

F

F

B

D

D+

D

The final overvalued results are ...

  • Gold: Molycorp
  • Silver: PCYC
  • Bronze: AMZN

In conclusion, I'm not advocating running out and buying calls on the undervalued stocks mentioned in this article. Nor am I saying go short or buy puts on the overvalued stocks either. I'm simply bringing to light just how a stock could be considered "Cheap" or "Expensive". The truth is, any stock here could be a great long term addition to a portfolio based on your risk appetite. I personally stay away from stocks with sky high valuations. Especially when the options market is signaling a possible pullback in stocks. I advise everyone to do their own research and make their own decisions when it comes to making any investment decision.

As always happy trading and stay hedged.

Remember equity insurance always looks expensive until you need it!

Disclosure: I am long: AGNC, APC, CAG, KERX, SLW. I am short: FE, FXE, FXY, SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. I do not recommend that anyone act upon any investment information without first consulting an investment professional as to the suitability of such investments for his or her specific situation.

Source: The Over/Under 'Value' Stock Shootout