Valuing Tech with PEG
We have all seen when the bull trade in a stock or sector has become too crowded. Recent examples include the internet bubble of 2000 and the oil spike of 2008. At the company level, can we determine these misppricings on simply a P/E or PEG basis? If so can we grab all cloud computing names at this time and buy a few out of the money put contracts month after month until the bubble bursts? It sure is tempting.
While its difficult to call the peak, I think these metrics may hold the key in determining when a company or industry has topped out. Valuation certainly is a time tested way to compare companies in the same line of business. Chinese Internet IPOs have seen some major run ups as late. Certainly its hard to justify paying steep premiums for uncertain growth and a limited track record.
How do we trade this phenomenon? One way to capitalize may be to buy shares in the most undervalued names and then buy puts several months out in those with the most expensive price paid for future growth. An example could be buying 100 shares of Microsoft for every OPEN put contract. In this example we are pitting a company with a PE of 11, PEG of 0.98 and a 2.5% dividend on the long side against a company with no dividend,a P/E of 142, and a PEG of 2.06 on the short side. Over time I like the odds of this trade giving us some decent returns. We are married to market specific risk impacting returns on both companies in much the same way, but are looking to capitalize on the valuations coming back in line with reasonable expectations.
Put simply, would you rather pay $2 for every percentage of growth in OpenTable or $1 for every percentage of growth in Microsoft. I like MSFT's track record and I feel that there's better value. The likelihood of the company continuing to deliver growth at a reasonable price is a nice opportunity at today's valuation.