How do you evaluate a large-cap stock?

[beth_leonard]

The Motley Fool Investment Guide had several great chapters on picking and evaluating small-cap growth stocks -- when to buy, when to sell (P/E/Growth < 0.6 means buy, = 1.0 means sell, > 1.4 means short). Does anyone have any solid advice for what numbers are good for large-cap stocks? Specifically, we're considering investing in Apple, but don't know at what price is a good price to buy it.

It's a solid, well-managed company, but I don't know if it's overpriced or not. We first talked about Apple several years ago, and now wish we'd bought then. The question is, should we buy now or not?

I'm halfway though Lynch's book, and there's a few other investment books on my stack. Right now we've been doing more selling and I feel like it's important to get some of this money back into the market and I specifically want to look at Apple to fill the "large cap tech sector" portion of our portfolio. Their P/E is currently 38, and P/E/G is 1.5, but I don't know if that's bad for large cap stocks of this type.

--Beth

Comments

[songmonk.livejournal.com]

If only evaluating companies were so simple.

[songmonk.livejournal.com]

Sorry, that wasn't a very constructive comment. Too tired to respond more completely right now though.

I would recommend comparing to "like" companies.

Also, remember that your PEG relies *heavily* on the estimates you use for growth (if you're using forward PEG), and also there are many games one can play coming up with a number for earnings which obviously affects your P/E. (One-time costs or revenues, etc.) Basically, how much do you trust your numbers? Do you agree or disagree with the "experts"? Do you know something they don't? Maybe you don't *know* anything they don't (and you probably don't for a widely-covered company like Apple), but you may be more optimistic or pessimistic than they are regarding the company's prospects.

But then, that's kind of what it comes down to, doesn't it? Because as far as the base numbers, you're looking at what everyone else is looking at. (And frankly, they're looking at a lot more than you're looking at.)

Also, "large cap" is far too simple. It varies industry to industry. A large cap tech company will probably have a drastically different PEG than a large cap retailer. Maybe justly so, maybe not. Of course all of these companies are priced according to what the market thinks.

Looking at PEG is close to the simplest "easy" valuation metric you can use, but it's just a starting point. It's not like you can arrive at a number and figure out whether Apple is a good buy or not.

But I'm sure you know that.

[motleypolitico.livejournal.com]

Your mileage may vary:

I tend to think most analysts overestimate the growth rates of large caps - the law of large numbers says it's just plain *hard* to continue to grow long term at the rates they tend to predict.

Also, a P/E of 38 would scare me on Apple. Are there really that many people left who don't have an iPod? Is the iTunes store really that profitable? Do you think that Apple's hardware platform is ready to grab another couple percent market share away from PC? Is iPhone really a huge product, given the unlock problems that remove a chunk of Apple's income from it?

Grabbing a couple percentage points of share in the PC arena seems the most plausible one to explain the high forward P/E ratio, assuming that there's a chunk of growth coming there, but I'm not sure I'd bet on it.

[beth_leonard]

It's not like you can arrive at a number and figure out whether Apple is a good buy or not.

*nod*

I'm still at the place where I don't know what I don't know, but I'm trying to learn. We've been doing a lot of selling of overvalued stocks lately, but I need somewhere to stick the money other than the S&P. If there's another way to evaluate stocks, I'd like to know what it is.

--Beth

[songmonk.livejournal.com]

Well, you're going down the right track. My above comment was of the nature of "well, it's complicated". Some people would then throw their hands up and say, "Well, I have no chance then." But learning what you're learning is the right path to being able to then discuss other things. Like you know what a P/E ratio is. And the P/E to growth ratio. So now you have a relationship between the two, some indication of value.

I honestly don't know too much on the topic. I think I started in the same place as you, reading stuff on TMF, Peter Lynch's book, that type of stuff.

As far as ways to value companies -- oh boy. There are many, many ways. Obviously it's an imperfect science which is why there's a whole industry surrounding that. :-)

When I first got excited about investing, I figured there were a lot of opportunities. And there are. But it's not as easy or obvious as some would have you think. Of course you can make money. But especially with widely-followed companies, you won't have information that anyone else doesn't have. Which doesn't mean you can't make money there. Plenty of people knew about Google and Apple before their runups.

Here's one thing. Like I said above, if you're looking at forward PEG, you're using at growth estimates. Where do those estimates come from? From analysts. You could do your own independent analysis on what you think Apple's future revenue streams will be and see how that matches up with the consensus estimates. Of course, this is not easy. The more familiar you are with their business, the better.

If you're looking for some situation where the P/E ratio is established (not too much funny business in calculating the earnings), the growth estimates are all in line from all the analysts, and the PEG is wildly out of line with the industry average, all so that you can find a wonderful buying (or shorting) opportunity, you're not going to find it with a company like Apple. If you're going to make money there, it's b/c you disagree with some of the assessments, not just because people haven't caught on to the numbers being out of whack. You might find that opportunity with a smaller company (though this is harder and harder in today's age of information), but in that case, how much do you know about their books? How much do you know about their business? Are the estimates accurate? In that case, it would help to be close to the ground (e.g., if you knew someone who worked for the company).

Anyway, I'm rambling again.

[patrissimo.livejournal.com]

I know a large cap tech growth company you could invest in :).

[beth_leonard]

Do you mean Google? Despite being far off-peak, the P/E is still over 40, even worse than Apple's (although P/E/G is better, although that's more of a voodoo number).

Or were you talking about Yahoo!? :-P

Although if Yahoo does start taking Google ads and ad revenue, that could help improve things there. Of course, from everything I've heard Yahoo axed most of their workforce without thought to which brains were key, so that's likely another bad spot for Yahoo.

MSFT is at a 17 P/E, which is more reasonable, but I don't think we'd touch that stock with a 10 foot pole. Jon has religious objections to the company.

ebay? amazon? I could be here all night.
--Beth

[patrissimo.livejournal.com]

Google, of course :). And I wouldn't call P/E/G a voodoo number at all. A company with a P/E of 20 growing at 10%/year and one with a P/E of 20 growing at 25%/year should have very different stock prices. Just how different depends on how long the high growth is expected to continue.

This comes straight out of the basic math that stock price = sum of discounted future cash flows, which is a reasonable first approximation for valuing stocks.

P/E/G is harder to estimate, sure, but comparing P/Es only makes mathematical sense when the Gs are identical.