After falling more than 38% from its high, many investors are now wondering whether Apple (NASDAQ: AAPL)
is a buy below $500. From a trading perspective, the answer is "no," and the only reason to think about buying Apple after such a big drop is based on fundamentals.
Fundamental analysts base their buy and sell decisions on earnings, cash flow or other valuation metrics. The logic is appealing. If a stock is trading at $10 a share and has earnings of $1 a share, for example, then the price-to-earnings (P/E) ratio drops to 5 from 10 if the price falls by 50%. A stock that was a "buy" at a P/E ratio of 10 must be an incredible bargain when the P/E ratio falls to 5, right?
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Sometimes, this logic works. At other times, buying is a mistake because the stock is headed toward bankruptcy. And once in a while, the big drop is followed by an extended consolidation period where the stock price goes nowhere.
This last scenario describes Netflix (Nasdaq: NFLX), which suffered a steep drop at the end of 2011.
The most important lesson Netflix offers potential Apple stock buyers is not to rush. Netflix fell for an extended period of time, and for months, technical and fundamental indictors showed the stock was oversold.
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After the initial decline ended, prices bounced higher, but then fell back toward the lows seen in the sell-off. While the bounce in Netflix seen early last year was tradable, anyone who held on too long saw their profits dwindle away. Interestingly, Netflix has been among the biggest gainers in the past two weeks, and relative strength (RS), shown at the bottom of the chart, offered a timely "buy" signal.
The next chart shows Apple, which in some ways looks like Netflix did in 2011. Any number of indicators could be added to the Apple stock chart to show that it is oversold.
The P/E ratio is shown in the middle of the chart with Bollinger Bands. When the P/E ratio falls to the lower Band, a stock is considered undervalued as Apple is now. By this measure, Netflix remained undervalued for most of 2012.
The RS indicator at the bottom of the chart shows that Apple is among the worst-performing stocks in the market right now.
RS shows when one stock or exchange-traded fund (ETF) is outperforming others. When looking at relative performance, the question for traders is not, "Is Apple a good buy or not?" Although based on the low P/E ratio, Apple is probably a good buy. The question should be, "Is Apple the best stock I could buy now?" Based on RS, it is not.
The final chart below reinforces this answer.
Apple makes up more than 13% of the Nasdaq 100 index, which is shown as the yellow line in the chart above. The purple line is the same index with Apple removed. Without Apple , the index would be at a 52-week high. Most stocks are doing well while Apple is not, something few investors would have thought was possible when Apple was trading near $700 a share last summer.
With so many stocks going up, investors should resist the urge to buy and hope for a bottom with Apple. There are many other stocks to buy now, and Apple's RS will turn up when it is time to buy that stock.
Action to Take --> As an alternative way to increase exposure to tech stocks, consider buying First Trust NASDAQ-100 Equal Weight Index (NASDAQ: QQEW). As its name implies, this ETF equal weights the components of the Nasdaq 100 and is not as vulnerable to weakness in any one stock.
This article originally appeared on ProfitableTrading.com:
"Is Apple a Buy Right Now? This Indicator Says, 'No!'"
(Note: My colleague Amber Hestla of ProfitableTrading.com has put the finishing touches on a report that answers ten commonly-asked questions about boosting income with options. If you'd like learn more about generating income using options, simply click here and tell us where to send the report.)
Michael Carr does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.