The Value Trap: Cheap And Expensive Stocks
Apple's stock is flirting with $600, and has a market valuation higher than that of Exxon (XOM). Priceline.com (PCLN) is flirting with $700. Micron Technology (MU) and Advanced Micro Devices (AMD) are trading below $10. Which stock is cheap, and which is expensive? Should investors care about the absolute price of a stock and its market valuation?
Valuing stocks is a tricky business, especially when emotions replace reason in investing. Some investors focus on accounting variables like Earnings Before Interest Depreciation and Amortization (EBIDA), and on the absolute price of the product. Stocks that usually trade above $100 are considered "expensive," while stocks trading below $10 are considered "cheap." According to this method, the stocks of companies Apple (AAPL), Intuitive Surgical (ISRG), Google (GOOG) and Terra Nitrogen (TNH) are "expensive," while the stock of Advanced Micro Devices, and Micron Technologies are "cheap."
Company | Recent Price | PE* | Operating Margin | Quarterly Revenue Growth |
AAPL | $582 | 10.76 | 25.80 | 73.30 |
PCLN | $645 | 19.34 | 23.59 | 45% |
ISRG | 529 | 30 | 28.17 | 27.6 |
TNH | 228 | 16.40 | 35.73 | 49.50 |
GOOG | 625 | 12.14 | 25.69 | 25.40 |
Forward Dec. 31, 2013
Source: Compiled from Yahoo.finance.com
Other investors look at the economic fundamentals of the company like profit margins, profit and revenue growth and market shares. According to this method, Apple, Intuitive Surgical, Google, and Tetra Nitrogen are cheap and AMD and Micron Technology are expensive. Which method is more sound?
Company | Micron Technology | Advanced Micro Devices |
Forward PE | 15.56 | 8.85 |
Operating Margin | 2.43 | 7.10 |
Quarterly Revenue Growth | -7.20 | 2.5 |
Recent Price | $8.82 | $8.20 |
Source: Compiled from Yahoo.finance.com
Certainly, the second method. Stock prices are accounting units. They don't tell us anything about the soundness of an investment. Company fundamentals, especially profitability, determines the return of funds invested in a company; and it is these returns that drive stock prices. Back in 2008, for instance, General Motors (GM) was trading at $2, and Apple at $102 - Apple was making plenty of profits, General Motors was losing money. One year later, Apple's stock almost doubled, while GM went bankrupt.
The bottom line: What looks as a value may be a trap. Don't judge a stock by its price, but its economic fundamentals
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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