The Nasdaq index made record highs on Monday, trading above the 5,140 level for the first time ever. This is understandably creating some concerns among investors, since valuations in some segments of the market could be getting stretched. However, rising prices don't mean each and every stock in the market is necessarily overvalued.
Valuation is about comparing a stock's price to the company's fundamental value, and past price performance does not tell you if a company is undervalued or overvalued. Even better, big tech companies Apple (AAPL +0.15%), Google (GOOG +0.01%) (GOOGL 0.09%), and eBay (EBAY 2.11%) are still trading at very reasonable valuation levels while offering profitable business models and exciting growth prospects.
Apple
With a market capitalization in the neighborhood of $730 billion, Apple is the biggest listed corporation on the planet. However, size is not the same as valuation, and Apple is still trading at a considerable discount versus most other stocks in the market. Apple carries a forward P/E ratio of 13 times earnings forecasts for the coming year, while the average company in the S&P 500 index trades at a significantly higher P/E ratio, in the neighborhood of 17.
This is not due to disappointing financial performance from Apple, far from that, the company's numbers are truly explosive. Apple announced a whopping increase in revenues of 27% year over year during the last quarter, while earnings per share jumped by an even stronger 40% on the back of expanding profit margins and stock buybacks reducing the amount of shares in circulation.
Source: Apple
The main reason why Apple is trading at such a moderate valuation is arguably product concentration risk. Apple made almost 73% of total revenues from the iPhone segment during the last quarter, and revenues in this segment grew by a jaw-dropping 55%. This shows the iPhone is clearly the company's biggest driver by a wide margin, even if demand has been truly encouraging lately, it sounds reasonable to assume that industry growth could slow down in the future.
With this in mind, investors may want to closely watch new growth initiatives such as Apple Watch, Apple Pay, Apple Music, and the revamped Apple TV. If these products and services gain some traction over the coming years, they could be a big win for Apple in terms of diversifying its portfolio and reducing the risks coming from its dependency on the iPhone.
Google
The Nasdaq index is up by more than 17% in the past year, but not every stock in the index has enjoyed the same kind of performance. Google stock is down by almost 5% over the same period, mostly because investors are concerned about changing industry dynamics and growing competition.
Based on data from eMarketer, Google owns a dominant market share of 31.5% in the online advertising industry. Facebook comes in the second position, with a market share of only 7.8%, however, the social network is rapidly gaining ground, as it only owned 4.1% of the online advertising market back in 2012.
Facebook and other smaller industry players are growing at a faster rate than Google. Besides, the online search giant is being hurt by falling ad prices, since growing segments such as mobile and YouTube are putting downside pressure on overall prices.
Source: Google
On the other hand, the company is still doing well. Sales excluding the impact from currency fluctuations grew 17% during the first quarter of 2015, and the business produces big profit margins in the area of 26% of revenue at the operating level.
Google stock is trading at a forward P/E ratio of 17 times earnings, in line with the market averages. But Google is still the global leader in the much-promising online advertising business, and the company should comfortably outperform most other names in the index by a considerable margin over the coming years. When looking at valuation in the context of the company's quality and growth prospects, Google stock looks like a smart purchase for investors.
eBay
eBay is currently trading at a forward P/E ratio in the neighborhood 18, roughly in line with the average company in the S&P 500. For this very reasonable price, investors are buying not one, but two remarkably strong businesses, now that the company is separating its PayPal and Marketplaces operations.
As the global leader in digital payments, PayPal is attracting a lot of attention from investors. The business has achieved massive scale, reaching more than 165 million accounts around the world and processing over 1 billion transactions in the first quarter of 2015. PayPal revenue grew at a staggering 17% year over year during the last quarter.
Source: eBay
The Marketplaces division is not growing as fast as PayPal -- gross merchandise value increased only 5% during the last quarter. However, this segment still has over 157 million active buyers and produces nearly $83 billion in gross merchandise value per year, so scale is quite considerable. Besides, the business model in this division is outstandingly profitable; management calculates operating margin will be in the range of 32%-34% during 2015.
For an average valuation, investors in eBay get to purchase both an explosive growth business (PayPal) and solidly profitable operation (Marketplaces), so this may be a good time to place a bid for eBay stock.
