A BUBBLE STOCK - IS EXTREME NETWORKS HITTING EXTREME PRICES?
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May 2, 2001
3:29 pm EST
New York (Jackson & Steinburger) - At $38.00/share today, Extreme Networks is clearly a bubble stock, sporting a Price Earnings Ratio (PE) of 475 time this year's earnings consensus and 237 times next year's earnings.
With analyst consensus estimates at $0.08 for the current fiscal year ending June 2001 and $0.16 for the fiscal year ending June 2002, we see these PE's as unsustainable, even in a marginally recovering economy.
Here's the numbers:
$38.00/0.08 = 475 PE for the fiscal year ending June 2001
$38.00/0.16 = 237 PE for next fiscal year
To justify high PE stocks, the common rationale is to evaluate a stock's PEG ratio (PE divided by growth rate). Generally a PEG ratio roughly equal to its growth rate is considered rational.
The question buyers should ask themselves is: "Does Extreme Networks have a 475% growth rate to support a PE of 475?"
Clearly not.
Again, using $0.08 as the consensus EPS for this fiscal year ending June 01 and $0.16 for the next year, it appears that Extreme Networks is projected to have a 100% growth rate.
With a 100% growth rate, one would then conclude that if Extreme Network's PE should also be roughly 100 times current year earnings of $0.08, the stock should be trading at around $8 per share.
Failing that test, our optimists might plead us to base fair valuation on next year's $0.16 EPS estimate to arrive at a fair value of $16/share, less than half of current lofty trading levels.
During the April 18th earnings conference call in which Extreme Networks announced a 7 cent per share loss (not to mention a -$0.64 non-proforma operating loss) for the January-March 2001 quarter, Extreme Networks management was asked if some projections of a loss of 10 cents for calendar year 2001 was in the cards.
Management at first said they would earn more than that but offered no specifics. When pressed further, they indicated they'd be profitable in calendar year 2001. How profitable? We can only wait and see.
And with current share prices for Extreme Networks reaching speculative levels, waiting on the sidelines is all we would be doing.
With 7 million shares short, much of Extreme Network's advance may be attributed to short shares being forced to cover, otherwise known as a "short squeeze."
Although we rarely short stocks, this is one we would feel comfortable shorting until valuations return to rational levels. Short squeezes are actually excellent opportunities to initiate a short because such rallies rapidly deflate once the buying associated with short covering margin calls plays itself out and the stock collapses.
A short position in Extreme Networks (or equivalent "bubble stock") can serve as an effective hedge against a pullback in the Nasdaq which has made substantial gains in the past 4 weeks and is likely to sell off on or before the May 15th Federal Open Market Committee meeting.
During Nasdaq pullbacks, high PE stocks usually take the brunt of the selling and EXTR would be no exception, having vaulted 216% from its April 4th low of $12.00 per share!
In the case of Extreme Networks, if this bubble reaches any higher, it'll escape the Earth's atmosphere.
Copyright (C) 2001 Jackson & Steinburger
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