# Are Tech Firms Overvalued

Question:  The chart below has information on the trailing PE ratio, the forward PE ratio, the PEG ratio and 2014 and 2017 gross income figures for 9 tech firms.

How do the trailing and forward PE ratios differ for these 9 firms?

What is the implied growth rate in earnings from the trailing PE ratios and the PEG ratio?  How do these implied earning growth rates compare to actual earing growth rates?

What is the implied growth rate in earnings based on the forward PE ratio and the PEG ratio? How do these implied earning growth rates compare to actual earing growth rates?

 Financial Statistics for Nine Tech Firms Trailing PE Forward PE PEG Gross Income December 2017 Gross Income December 2014 AAPL 20.35 16.56 1.46 88.2 70.5 AMZN 159.84 79.55 2.51 65.9 26.2 MSFT 52.8 22.91 2.07 72 60.5 FB 27.73 21.49 1.1 35.2 10.3 NFLX 169.65 85.72 2.19 4.03 1.75 GOOG 53.96 26.03 1.75 65.27 40.69 NVDA 40.83 35.11 2.17 5.82 2.6 EA 52.57 20.61 1.68 3.87 3.09 TXN 26.17 18.41 1.41 9.61 7.43

Analysis:

Below is information on the trailing and forward PE ratios for the 9 tech firms.

 Comparing Trailing & Forward PE Ratios Trailing PE Forward PE Diff. AAPL 20.35 16.56 3.79 AMZN 159.84 79.55 80.29 MSFT 52.8 22.91 29.89 FB 27.73 21.49 6.24 NFLX 169.65 85.72 83.93 GOOG 53.96 26.03 27.93 NVDA 40.83 35.11 5.72 EA 52.57 20.61 31.96 TXN 26.17 18.41 7.76 Average 30.83 Paired t test 0.018

The trailing PE ratio is larger than the forward PE ratio for all 9 firms.

This occurs because analysts are optimistic that forward earnings will exceed past earnings.

The paired t-test indicates we should reject the null hypothesis that the mean difference between the trailing and forward PE ratio is zero.

Note:   The implied earnings growth forecast used in a PEG ratio can be obtained by dividing the PE ratio by the PEG ratio.   The definition of a PEG Ratio is PE/G.   This means PE/PEG or PE/(PE/G) is equal to G.

The actual annual growth rate of earnings between 2014 and 2017 is ((E17/E15)(1/3) -1.

Below is the comparison of implied growth rates from reported trailing PE and PEG ratios to actual earnings growth rates.

 Implied vs. Actual Growth Rates Trailing PE Ratio PEG Ratio Implied Growth Rate Actual Average Annual Rate of Growth in Gross Profits 2014 to 2017 AAPL 20.35 1.46 13.9% 7.8% AMZN 159.84 2.51 63.7% 36.0% MSFT 52.8 2.07 25.5% 6.0% FB 27.73 1.1 25.2% 50.6% NFLX 169.65 2.19 77.5% 32.1% GOOG 53.96 1.75 30.8% 17.1% NVDA 40.83 2.17 18.8% 30.8% EA 52.57 1.68 31.3% 7.8% TXN 26.17 1.41 18.6% 9.0%

Implied growth rate based on trailing PE ratios.

For 8 of the 9 companies the implied growth rate from trailing PE ratio and reported PEG is larger than the actual growth rate in gross earnings.

Only NVDA had an implied growth rate lower than its actual growth rate.

Below is the comparison of the implied growth rates from reported forward PE ratios and PEG ratios to actual earnings growth rates

 Implied vs Actual Growth Rates Forward PE PEG Implied Growth Rate Actual Average Annual Rate of Growth in Gross Profits 2014 to 2017 AAPL 16.56 1.46 11.3% 7.8% AMZN 79.55 2.51 31.7% 36.0% MSFT 22.91 2.07 11.1% 6.0% FB 21.49 1.1 19.5% 50.6% NFLX 85.72 2.19 39.1% 32.1% GOOG 26.03 1.75 14.9% 17.1% NVDIA 35.11 2.17 16.2% 30.8% EA 20.61 1.68 12.3% 7.8% TSN 18.41 1.41 13.1% 9.0%

Implied Growth Rate based on forward PE ratios

For 5 of the 9 firms the implied growth rate based on forward PE ratio is larger than the actual growth rate.

The other 4 firms have higher actual growth rates than implied growth rates

Discussion:

Are these tech stocks overvalued?

My view is there is a lot of unjustified optimism about these stocks.

Many of these firms had high actual growth rates 2014 to 2017.   This actual growth rate may be unsustainable.

Many of the implied growth rates calculated here are even higher than current unsustainable growth rates.

Perhaps analysts are using the growth rate of net taxes in their PEG estimates but tax cuts result in a one-time shift in earnings growth.  Soon the tax cut will define net earnings in the bae year of the earnings growth calculation.   This should decrease growth rates and cause the PEG ratio to rise.

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