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[Alfred E. Neuman]

Chips show signs of tiring
Commentary: Intel's reluctance to rally sending signal

By Tomi Kilgore, CBS.MarketWatch.com
Last Update: 6:02 PM ET Sept. 14, 2004


NEW YORK (CBS.MW) -- Should investors cheer the new high in the chip sector, or worry about Intel's reluctance to rally? The answer should come fairly soon.

A surge in the semiconductor sector over the past few days in the face of lowered sales outlooks from individual companies has given the impression that chip stocks have broken out from their recent doldrums.

Meanwhile, the stock of sector bellwether Intel continues to struggle below resistance, and is showing signs that another downward push is likely to be just around the corner.

The speed and depth of any pullback this week will determine if the recent rally was real or just a bear market bounce.

Chip sector tracker peeks above resistance

The Merrill Lynch Semiconductor Holdrs (SMH)had rallied 10 percent in the prior four sessions, and reached a 5-week high on Monday. On Tuesday, the chip sector tracking stock closed up 16 cents at $31.07, but had been up as much as 26 cents.

The SMH was still down 18 percent from the end of June and 32 percent from its January 2004 high ($45.78).

But fact that the recent gains came despite lowered sales outlooks from several chip companies, including LSI Logic (LSI), Broadcom (BRCM), Texas Instruments (TXN), Atmel (ATML) and National Semiconductor (NSM), as well as negative comments from a host of Wall Street analysts, provided some hope that the sector was washed out, and had already priced in all the bad news it was going to see in the short-term.

The SMH ran up to a high of $31.46 on Monday, breaking above resistance at the Aug. 23 high of $30.99. Finally, a higher high. Given that it had been stuck following a pattern of lower highs and lower lows since January, this appeared to be significant.

But despite Monday's strong performance, the SMH actually flashed a warning sign.

The session's open ($30.80) was near its close ($30.91), and both were buried in the middle of a wide intraday range (low of $30.48 and high of $31.46). According to followers of the candlestick charting technique, this "high wave" pattern suggests supply and demand may be reaching equilibrium. See more about candlestick charting.

Meanwhile, the group's de facto leader, Intel (INTC), had gained "just" 5.5 percent over the prior 4 sessions, and failed Monday to reach the top of the resistance range -- $20.18 to $21.26 -- created by the Sept. 3 downside "gap. See about SMH component weightings.

"Gaps" are openings in a chart, created when one day's high (or low) fails to overlap with the prior session's low (or high). The entire "gap" is considered resistance (or support) when revisited, until it is filled on a closing basis, given that those caught by surprise would be happy to escape from their positions with only a slight loss.

On Monday, the Intel could only reach a 1 1/2-week high of $21.18, before backing off to $20.80. The stock opened higher on Tuesday ($20.82), but failed to challenge the prior session's high (Tuesday's high was $20.96) before closing down 3 cents at $20.77.

Without some fresh ammunition -- not another sales warning from yet another chip maker -- it appears Intel and the sector may need to regroup before making another run higher.

Counterintuitive rallies -- when stocks gain on apparent bad news -- are either erased very quickly or are a sign of the beginning of something bigger.

There should be some minor support in the SMH in the $30.35 to $30.55 area, and in Intel at the $20.50 to $20.55 level. If a pullback slices through those levels like there was nothing there, get ready for sharp slide and a likely return to prior lows.

If those levels manage to put up a fight, however, perhaps there will be something bigger coming over the next few days.

Either way, the charts appear to suggest a pullback is coming.


Tomi Kilgore is a reporter for CBS.MarketWatch.com in New York.

[Alfred E. Neuman]

Fecho em zona de forte resistência:

23,6% retracement fibonacci
LTd
EMA 200

[Alfred E. Neuman]

chart

[Alfred E. Neuman]

Stock Strategist: The Nasdaq Isn't a Sell--It Just Looks That Way

How Morningstar values the companies in the Nasdaq 100 Index.


by Mark A. Sellers | 09-01-04 | 06:00 AM

There's been a lot of talk lately about the valuation of growth and technology stocks. In recent months, I have read numerous opinion pieces on this subject by journalists, academics, pundits, and money managers. All of these articles and papers came to a similar conclusion: Growth stocks, and technology stocks in particular, are dramatically overvalued. One money manager even claimed that the Nasdaq 100 is 60% overvalued. Many of these pundits came to this conclusion by looking at the aggregate P/E ratio of the Nasdaq 100, an index that includes 100 of the largest stocks listed on the Nasdaq exchange.

But there's a problem with these arguments: None of them has looked at the valuations of individual companies within the index. They all use aggregate data, such as the average P/E or P/B ratio of the stocks within the index. Even writers who claim to be disciples of Warren Buffett--in other words, those who think stocks should be valued based on the discounted value of future free cash flows--base their arguments on aggregate valuation shortcuts rather than discounted cash-flow (DCF) models for individual companies.

The way I see it, an index is just a large group of stocks that can be valued individually, and then summed up to produce an aggregate valuation. Skipping the first part (valuing the individual stocks within the index) results in a simplistic conclusion that may not reflect economic reality.

People use valuation shortcuts because creating DCF models on all the companies within an index would be a monumental task. It takes a whole staff of analysts to do it, and frankly, few research shops base their published valuations on DCF models. So as a shortcut, most people (including most analysts) use the P/E ratio and PEG ratio. Unfortunately, like many things in life, the simplest method of doing something is not always the best.

Morningstar's Valuation Model

Morningstar has 75 stock analysts, and all of our analysts use the same discounted cash-flow model developed in-house to come up with fair value estimates for individual companies. These DCF models all use the same basic inputs (such as the risk-free Treasury bond rate, inflation rate, market risk premium, etc.) and are completed by our analysts, who are experts in one or two industries.

We take the economic effect of stock-option issuance into account when we value companies--something the P/E ratio doesn't do. Most importantly, our analysts have no conflicts of interest, so they have no reason to be overly bullish on any company we cover. In fact, they have an incentive not to be too bullish, lest they get angry letters from our customers when a stock crashes.

Thus, we can get an unbiased valuation for an index such as the Nasdaq 100 by looking at the valuations of the stocks within that index, as estimated from our analysts' individual DCF models.

Morningstar analysts cover 93 of the stocks on the Nasdaq 100 Index. That means, using our fair value estimate for each stock, I can come up with an aggregate valuation for the Nasdaq 100 Index using the DCF models for each individual company. As far as I know, no one else has ever done this. The results are surprising.

Valuing the Nasdaq 100

Based on our analyst fair value estimates for each company, the Nasdaq 100 Index is about 5% overvalued right now. However, there is a lot of variation within the index. Many stocks are undervalued, while quite a few are dramatically overvalued. Here's the methodology I used to come up with this valuation.

First, I downloaded the names and tickers for each of the 100 companies in the index from Morningstar's database. I expelled from the list the seven companies we don't cover: Patterson PDCO, PanAmSat SPOT, Dentsply International XRAY, Invitrogen IVGN, Cephalon CEPH, Compuware CPWR, and Kmart KMRT.

Next, I consulted Nasdaq.com to get the most recent index weightings of each of the remaining 93 companies as of Aug. 27. The stocks within the index are mostly weighted by market cap, though there are some inconsistencies. Yahoo YHOO, for example, is weighted behind several smaller companies--I'm not sure why, but I assume this was a conscious decision by the committee that manages the index. Microsoft MSFT has the largest weighting, at 9.04%, and First Health Group FHCC the smallest, at 0.13%. The 93 stocks we cover comprise a little more than 98% of the index weighting. The seven stocks we don't cover make up the remainder.

After compiling this 93-company list, I downloaded price, fair value, and other relevant data from Morningstar.com. I calculated the premium/(discount) to fair value for each stock, based on the price and fair value of each as listed on Morningstar.com as of Aug. 30. I then sorted the list of stocks by percentage weighting in the index, with Microsoft at the top and First Health at the bottom.

Finally, I broke this list into four groups based on percentage weightings within the index: 1 through 10, 11 through 20, 21 through 30, and 31 through 93. By doing this, I was able to get valuation results for different subgroups within the index, based on market cap. The results are shown in the table below.


Results

As you can see, the top 10 weighted stocks in the index are high-quality companies: Microsoft, Qualcomm QCOM, Intel INTC, Cisco Systems CSCO, eBay EBAY, Amgen AMGN, Dell DELL, Nextel NXTL, Comcast CMCSA, and Starbucks SBUX. Morningstar rates eight of these 10 companies as "wide moat"; Starbucks and Nextel are rated narrow moat. These 10 make up about 41% of the index weighting. They are about 3% overvalued, according to our fair value estimates for each stock, and their average Morningstar rating is 2.8, which is essentially a "hold" rating. Two of these companies are rated 1 star, one is rated 2 stars, four are rated 3 stars, and three are rated 4 stars. None is rated 5 stars (strong buy).

This is not a good time to buy the top-weighted stocks in the index, but it's not a great time to sell them, either. Hedge fund managers who are placing bets against the Nasdaq 100 are essentially shorting a group of wide-moat, high-quality companies that are about fairly valued, by our estimates. This doesn't sound like a great strategy to me, given that a lot of individual stocks are overvalued by far more than the aggregate index.

The next group of 10 stocks, weighted 11 to 20, does raise some red flags, however. On average, these stocks are about 14% overvalued. Apple Computer AAPL, at 55% above its fair value estimate, is the most overvalued stock in the group. On the opposite end of the spectrum, InterActiveCorp IACI is 42% below fair value. Six of these 10 stocks are rated 1 star, none is rated 2 stars, two are rated 3 stars, one is rated 4 stars, and one (InterActive) is rated 5 stars. On average, the star ratings of this group of 10 stocks, which comprise 16% of the index, is 2.2, right between a sell and a hold rating. If you want to short stocks in the Nasdaq 100, this group of 10 are the best candidates.

The next group of 10, ranked 21 to 30 in terms of percentage weighting in the index, is overvalued by just 2%, with an average star rating of 2.9. This group makes up about 12% of the aggregate index weighting. At the extremes within this group, Research in Motion RIMM is overvalued by 54%, while Apollo Group APOL is undervalued by 29%, based on our DCF models.

The final group of 63 stocks makes up a 29% weighting in the index. This group is overvalued by about 4%, by our estimates, with an average star rating of 2.8. Again, not a buy, but not a sell, either.

Using a weighted average for the whole index, the Nasdaq 100 is overvalued by about 5.0%, according to Morningstar estimates of individual firm values. According to us, the index is a hold. Further, when I sorted the whole list in descending order by ratio of price to fair value, I found that the median stock ( Altera ALTR) is almost exactly at fair value.

For a sense of historical perspective, in early October 2002, our fair value estimates put the median stock on the Nasdaq exchange at about 24% undervalued (though at the time we didn't cover as many stocks as we do today). Since then, the index has risen 51%. In February 2004, the median stock on the index was 29% overvalued, by our estimates. Since then, the Nasdaq has fallen by 12%. Here's a historical graph of our price/fair value ratios since late 2001.

More Traditional Valuation Metrics

I also duplicated the analysis above using shorthand valuation metrics such as P/E ratio, price/book, PEG, price/cash flow, etc. By looking at the same groups of stocks through a different lens, I got a different, more bearish, picture:



This analysis would seem to show that the stocks in the Nasdaq 100 are dramatically overvalued. This is particularly true of the smaller companies in the index. The smallest 63 companies have a weighted-average forward P/E ratio of 52, and a trailing price/cash flow ratio of 45. This is very high by any historical standard. Even the top group of stocks, the largest companies, seem dramatically overvalued using shorthand valuation metrics. This data is what the pundits point to when they write articles about the dramatic overvaluation of the Nasdaq, and what hedge fund managers cite to justify shorting the Nasdaq 100.

Unfortunately, the stocks with the highest weighting in the index also have the lowest valuations. This means that shorting the Nasdaq 100, in aggregate, seems illogical. Why not short the smaller stocks only--those that are the most overvalued? Even the smaller stocks in the index are liquid enough for most funds to get in and out of easily.

DCF vs. Shortcuts

The conclusion boils down to this: Which do you believe more, DCF models on individual companies that are developed by analysts with no conflicts of interest who specialize in their respective industries or shorthand methods of valuation that are prone to GAAP accounting distortions and focus on the very short-term future or the trailing 12 months?

For my money, I'll take the discounted cash-flow valuation methodology every time. I believe it shows a more robust picture that is consistent with economic reality. The Nasdaq isn't a sell right now, it's a hold.

This in no way means that the index can't decline further--in the short-term, price and fair value can diverge dramatically--but betting on a dramatic pullback does not seem to be logical unless you feel comfortable making a short-term market call based on nonfundamental factors.