Overvalued Tech Stock Poised To Plunge

Melvin Pasternak's picture

Wednesday, February 17, 2016 - 7:30am

by Melvin Pasternak

Most investors are aware that the tech-heavy Nasdaq has a tendency to lead the market both up and down, and the current sell-off is no exception. The Nasdaq Composite is off more than 15% from its late-December highs, while the broader market is down just 10%.

Tech stocks often take the brunt of the selling because they tend to carry higher valuations and are thus considered more risky. 

Since there doesn't seem to be an end yet in sight to the current market correction, shorting overvalued tech stocks is a sound strategy to profit from this downtrend.

And Universal Display (Nasdaq: OLED) is a perfect candidate. Started in 1994, Universal is a leader in organic light emitting diode (OLED) technology, which contains organic films that emit light when struck by electric current.

Universal own nearly 3,600 patents in the OLED space and also works with major universities on research.

OLED technology is used for full-color displays in products such as smartphones, tablets and TVs. It's both lightweight and power-efficient, while also offering superior color to many competing technologies. For instance, in the television market, its picture quality has helped it seize market share from its main rival, liquid crystal display (LCD).

While the OLED market could be a big growth area, Universal Display's stock appears to have gotten ahead of itself.

When third-quarter results were released in early November, shares spiked nearly 13% on strong headline numbers. Revenues were up almost 20% year over year, while earnings per share (EPS) jumped 67% to $0.15, easily clearing the consensus estimate.

But looking deeper, nine-month results were far less impressive. Revenue declined almost 5% from the same period of 2014, while EPS dropped sharply from $0.61 to a loss of $0.07. 

For the full year, scheduled to be reported on Feb. 25, analysts are only projecting revenue growth of 4.8% to $200.1 million, a dramatic drop from the nearly 50% average annual growth seen in the prior three years.

With revenue growth stalling, Universal looks overvalued based on a number of metrics. For comparison, we'll use the S&P 500 Information Technology Index.

OLED has a trailing price-to-earnings (P/E) ratio of over 200 -- more than 10 times the index's earnings multiple. And its forward P/E of around 31 is nearly twice the IT index's 15.8.  

This same lush valuation shows up in OLED's price-to-sales (P/S) ratio of 10.9 versus 3.01 for the index. Finally, OLED's price-to-book (P/B) is 4.4 compared with 3.9 for info tech.

Given the strong possibility of continued weakness in tech stocks and Universal's rich valuation, the stock appears vulnerable -- and its chart agrees.

OLED Stock Chart

OLED's price action is marked by large moves -- both up and down -- within relatively short time periods. 

On the chart, we can see that OLED advanced about 50% between June and August 2013. It then traded sideways for several months in an irregular rectangle before breaking down through its uptrend line in March 2014. 

This brings us to another technical characteristic. OLED should have found support at the previous low near $26. Instead, it broke to a lower low near $22 in May of that year.

OLED's next major move was decisively higher, with shares nearly doubling in about four months. The stock then lost almost 40% of its value by November 2014.

After a brief period of consolidation, OLED once again roughly doubled, blowing through resistance near $40 and hitting a peak around $56 in early June 2015, just five months later. Shares then lost more than 40% by autumn, breaching the $40 level where support should have kicked in, and hitting a low near $32.

From that low, the stock shot up 80% in just over two months, fueled in large part by rumors that Apple (Nasdaq: AAPL), which uses OLED technology in its Apple Watch, was going to adopt the technology for the iPhone in 2018. 

But these rumors are unconfirmed and, even if the chatter turns out to be true, it will be more than two years before the financial effect is felt by Universal. 

The nominal new high near $58 made in early December quickly failed. Shares are now down about 22% from that peak. A very steep downtrend line intersects the chart near $48, which we will use for a stop-loss level. 

The first major support level is around $32.50, which served to spur buying interest between August and October of 2015. A major trendline in force from May 2013 intersects the chart near $32, meaning the stock could fall to that level and still be in a major uptrend. 

While OLED technology may indeed have long-term potential, Universal Display looks vulnerable to a decline over the next few months, especially given investors' penchant for unloading high-P/E technology stocks in a rocky market.

Recommended Trade Setup:

-- Sell OLED short at the market price 
-- Set stop-loss at $48.55
-- Set price target at $32.55 for a potential 28% gain by Q3 2016

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This article was originally published on ProfitableTrading.com: Overvalued Tech Stock Poised to Plunge​

Melvin Pasternak 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.