OptionSage submits:
Phil often uses physics to describe movements of the markets and this weekend might be an appropriate time to review one lesson in particular from December 20, 2006:
“The larger the Apogee (the point at which the market is furthest above "normal") the more terrifying the drop back to the Perigee (underperformance) will seem, even though there are literally trillions of astronomical bodies that go through this cycle every single day without crashing!
“The perigee is a good time to eject excess mass (nervous investors) as you prepare to leave them, and previous market highs, behind”
The market’s move on Friday has spooked a lot of investors and perhaps rightly so. If we restrict ourselves to earthly objects for a moment then we know well that gravity dictates:
“What Goes Up Must Come Down!”
Unless the market swings from its respective Apogee to its respective Perigee and rebounds with strength, gravitational pull can be deadly and parachutes need to be deployed quickly as the earth approaches quickly when traveling at terminal velocity and nobody wants to feel that thud upon impact!
What does it mean for us traders? Firstly, be cautious of the flagship stocks that garner mass attention after they have run up tremendously. For example, Cramer anointed Apple, Research in Motion, Google and Amazon as his Four Horsemen. I don’t know if Cramer really wanted to follow through with that description as the typical reference to the Four Horsemen is “The Four Horsemen of the Apocalypse” and refer to the forces of man’s destruction: Pestilence, War, Famine and Death. Surely Cramer didn’t miss this so it proves to be a particularly fascinating description of his favorite stocks!
It’s especially interesting because as the old boxing analogy goes “the bigger they are the harder they fall” and Apple, Research in Motion, Amazon and Google have all had big runs. In fact, Google might have been the first to fall following its $35 drop subsequent to its earnings report. Of course, as Phil pointed out, the Google miss was attributable in some part to an investment in resources which really is an investment in the future so how can the investment community complain?!?
Nevertheless the stock took a tumble. What about Apple then? Apple is due to report earnings July 25, 2007 – after the market closes. As Reinharden pointed out in comments Friday: it is prudent to have your Apple plays in place the day before earnings because AT&T reports earlier in the day (before the market opens) and could provide a hint as to what numbers Apple really posted for iPhone sales. Insiders tell me the figures of 700,000 are preposterous but Phil has done back of the envelope calculations in the past to show why it just might be possible and he’s right far too often for me to argue the case.
It’s much easier to discuss the fundamentals of Apple anyway!
Apple is trading at a P/E of 45! Now that’s not so surprising but it is worth noting that this P/E is associated with a $143 stock price after the stock has increased almost 60% in 3 months. I hate to be the naysayer amongst the “Go Apple and Hit $200” crowd but…based on projected earnings of $4.13 for fiscal year end 2008, Apple’s P/E must increase to almost 50 for the stock to reach that lofty $200 level and earnings must come in-line with estimates. I wouldn’t be in a rush to put my money on the multiple so if it gets there my bet is it gets there because analysts have underestimated projected earnings.
This simple analysis doesn’t in any way preclude the possibility of Apple going higher but I have to say that if I hadn’t placed any bets on Apple yet I wouldn’t be in a big rush to do so at these levels.
Research in Motion broke out of its long-time high $50s – low $80s range in October 2006 following its earnings report and never looked back. Research in Motion currently has a P/E of 60 though EPS growth projections for 02/2008 and 02/2009 are an astounding 71% and 37% respectively according to Zacks so the $40Bn company may indeed have another $$10Bn-$15Bn to go but again it takes a brave investor to go long such a volatile company that is technically overbought.
And finally, to Amazon: I can’t think of a single person who projected Amazon would spurt higher towards a double in just a few months but that’s exactly what it did! Amazon too trades an incredible P/E of 60 with fiscal year 2008 EPS growth projections coming in at 28%. For me, many of the reasons that caused Amazon to shoot upwards can be applied to EBay and yet EBay trades at about half the multiple and still has respectable EPS 20% growth projections ahead. I know which stock I’d rather be in.
The bargain of the group based on P/E multiples and projected EPS growth would seem to be Google. Google trades at a multiple of 45 and a forward multiple of just 27 despite EPS growth projections of 30%. A continued sale will be an opportunity in my view though it may take some time for the dust to settle following the $35 drop since Friday. As an aside, it was curious to see Cramer rattled and failing to get behind the company.
Keep in mind that the price tends to create distortion in the minds of most investors. Price does not indicate value and in percentage terms there really is no difference between a $550 stock dropping $28 and a $55 stock dropping $2.80. Would Cramer really have panicked if a $55 stock he was behind dropped $2.80? I doubt it! Not when the company is investing in its future through aggressively hiring the best talent, but call me old fashioned for looking the fundamentals before looking at the price to dictate trading decisions.
Have a fantastic week!
OptionSage
