Markets are wading through the heart of earnings season, and this is an ideal time to find opportunities in the market. With critical semiconductor names reporting quarterly results over the past week, let's take a look at which sector players are undervalued or overvalued compared to peers. I've begun by looking at the components of the iShares PHLX Semiconductor ETF (SOXX) and selecting the top ten holdings by weighting in the ETF. (See also: Is the Semiconductor Tide Rising?.)
Looking at the numbers, it would seem valuations are all over the place. For example, Lam Research (LCRX) has a forward P/E of 13, yet according to the data, EPS are expected to decline next year. Meanwhile, Nvidia Corp. (NVDA) earnings are expected to grow only 12%, yet the forward P/E is 41! Meanwhile, Micron (MU) has the highest projected EPS growth, yet MU trades at the lowest forward P/E. You know what all this confusion means? There's an opportunity lurking in the market because of mispriced valuations.
Next, we turn to revenue projections, which is just as important as earnings. Actually, I think they are more important than earnings. Revenue quantifies top Line growth, while earnings can be influenced by operational cuts and share repurchases. Share repurchases reduce the number of shares outstanding, so a company can have net income that remains flat or even declines, but because there are fewer shares outstanding EPS can increase. I certainly appreciate EPS growth, but I’d prefer to see revenue growth.
With revenue estimates from Yahoo Finance for each company, I've calculated revenue growth rates and price to sales ratio. The last column PSG is price to sales/growth, which is similar to a PEG ratio. It tells me what companies are cheapest by revenue growth rates. Again, here we see that Lam Research has a negative revenue growth rate, but it has a P/S ratio that is higher than Micron. Again, there appears to be valuation confusion among market participants.
If you have ever played fantasy football or fantasy baseball, then you are probably familiar a rotisserie league, otherwise known as a roto-league. I used the same method in the final step, going through each of the valuation columns and assigning the most undervalued company with a 10 and the most overvalued company with a 1 and then combined the total. With Six columns and 10 potential point the highest score a company could get is a 60, while the lowest score would be a 10.
The table above tells a very different story than the confusing tables we saw earlier. The table shows which companies have the highest valuations and which have the lowest valuations compared to their peers. We can now clearly see that Micron is the most undervalued company on our list, while Lam is the most overvalued. It can be tricky at times, because an investor looking to purchase a stock may look at only one metric. For example, Company X is trading at a P/E of 10, while Company Y is trading at 20. Therefore company X must be cheap because Company Y is trading at a valuation two times as high.
In this case, you can see that QCOM has the very low Forward P/E with a score of 9 points, but in fact we discover that QCOM has the worst EPS and revenue growth rates. QCOM doesn't look so cheap in that light. Meanwhile, MU has the fastest EPS growth, the most reasonable Forward P/E, and lowest PEG. Additionally, these superlatives come not just from cutting expenses and pumping share buybacks, but from solid revenue growth. Micron may not have the revenue growth rate as fast as NVDA, but MU also doesn’t come with NVDA's nosebleed valuations.
Who would have thought that fantasy sports and investing had so much in common?
Michael Kramer and the cliens of Mott Capital Management, LLC own Skyworks Solutions, (SWKS). Michael Kramer is the founder of Mott Capital Management LLC, a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request the advisor will provide a list of all recommendation made during the past twelve months. Past performance is not indicative of future performance.