My very first experiment with the TMFULOI proved quite successful, with all five companies heading lower over the course of a two-month period and four of five underperforming the S&P 500. The second group of overvalued companies, unveiled last June, didn’t perform as well as the first group; however, it’s still quite evident that the TMFULOI appears to have some substance based on these results:
| Company | Performance Since June 12, 2012 | Performance Relative to S&P 500 |
|---|---|---|
| LinkedIn (NYSE:LNKD) | 72.2% | 57.4% |
| Alexion Pharmaceuticals, Inc. (NASDAQ:ALXN) | (8.8%) | (23.6%) |
| Baidu.com, Inc. (ADR) (NASDAQ:BIDU) | (20%) | (34.8%) |
| Gold Resources | (48.8%) | (63.6%) |
| SolarWinds (NYSE:SWI) | 21.6% | 6.8% |
Source: Yahoo! Finance, author’s calculations.
LinkedIn once again proved to be the primary thorn in my side, but overall, with the S&P 500 up 14.8% during the period, this group of companies underperformed the broad-based index by an average of 11.6% per company!
Therefore, the time has come once again to unveil the next group of overvalued companies according to my formula and see if I can make it three-for-three! As usual, I’ve excluded royalty trusts and clinical-stage biotechnology companies, as they’d significantly skew the results. In addition, I’ve got a new twist that I’ve added to the index that should help factor in growth prospects rather than penalize companies for their high ratios and give me/us a better understanding of just how overvalued these companies are.
The latest stock screen run on Motley Fool’s CAPS Screener turned up 19 companies, of which the six below qualified under the TMFULOI parameters:
| Company | Price/ Book | Price/ Sales | Price/ Cash Flow | TMFULOI |
|---|---|---|---|---|
| 21.1 | 21.7 | 82 | 124.8 | |
| ARM Holdings (NASDAQ:ARMH) | 11.3 | 23.8 | 64.5 | 99.6 |
| Aspen Technology (OTCBB:AZPN) | 26.9 | 10.4 | 21.7 | 59 |
| SolarWinds (NYSE:SWI) | 11.3 | 16.1 | 30.1 | 57.5 |
| MercadoLibre (NASDAQ:MELI) | 13.7 | 10.3 | 33.2 | 57.2 |
| Tile Shop Holdings | 18.1 | 13.1 | 15.9 | 47.1 |
Source: Morningstar, author’s calculations.
The aforementioned new twist, which comes from the suggestion of a flaw in the original TMFULOI formula by my Fool colleague Rick Munarriz back in June with regard to Baidu, is that I plan to divide the TMFULOI value by the forward year’s estimated revenue growth as determined by Wall Street to get a newly adjusted TMFULOI value that factors in growth.
| Company | Price/ Book | Price/ Sales | Price/ Cash Flow | TMFULOI | Forward Sales Growth % | Adjusted TMFULOI |
|---|---|---|---|---|---|---|
| ARM Holdings | 11.3 | 23.8 | 64.5 | 99.6 | 19.6% | 5.08 |
| 21.1 | 21.7 | 82 | 124.8 | 38.9% | 3.2 | |
| Aspen Technology | 26.9 | 10.4 | 21.7 | 59 | 19.1% | 3.09 |
| SolarWinds | 11.3 | 16.1 | 30.1 | 57.5 | 22.7% | 2.55 |
| MercadoLibre | 13.7 | 10.3 | 33.2 | 57.2 | 22.4% | 2.53 |
| Tile Shop Holdings | 18.1 | 13.1 | 15.9 | 47.1 | 24.1% | 1.95 |
Sources: Morningstar, Yahoo! Finance, author’s calculations.
ARM Holdings plc (ADR) (NASDAQ:ARMH)
ARM Holdings produced the second-highest TMFULOI value, but, based on the recently added growth factor, is hands-down the most overvalued company out there according to my formula. ARM has been relying on its stable lead in mobile and tablet processing IP architecture over the past couple of years, but could be “priced to perfection” according to technology guru and Fool colleague Evan Niu. Evan noted in January that ARM’s royalty rate per unit has been on an almost precipitous decline since 2006. While this doesn’t put ARM in any danger of losing its IP superiority in mobile devices, it could continue to slow down its growth rate, which may spell disaster at such lofty valuation multiples.
