Shares of Swedish communications equipment giant Telefonaktiebolaget LM Ericsson (ERIC, Financial) spiked more than 11% on Friday to trade around $13 per share before pulling back. The company announced strong fiscal fourth-quarter and full-year 2020 results before the market opened.
Ericsson's market value has doubled since bottoming on March 16. This bull run has coincided with a significant recovery in global stock prices following the February to March plunge. The stock has also benefitted from increased optimism due to the opportunity the company has in the 5G market.
The price-earnings ratio has risen significantly to 23.57, which suggests a potential case of overvaluation based on the Peter Lynch earnings line.
Recent quarterly results and growth
Ericsson posted earnings per share growth of 68.75% to 27 cents, which beat analysts' expectations of 21 cents. The company's top line for the quarter grew 13.71% to $8.08 billion, which again was better than the consensus estimate of $7.75 billion.
The gross margin also improved to 40.6% from 36.8% on a year-over-year basis. This helped it to deliver a strong bottom line.
The company appears to be well positioned to capitalize on the expected adoption of 5G technology starting in 2021. This provides an avenue for sustainable top-line growth, which, coupled with improving margins, promises better earnings.
Ericsson's bottom line has improved over the last few years to return to profitability after dropping into negative territory in fiscal 2017. Revenue has also increased in each of the last two years after dipping in 2018.
Valuation
From a valuation perspective, Ericsson appears to be trading at a higher valuation multiple than the Peter Lynch value. However, when we factor in expected earnings growth, the company's immediate and long-term outlooks appear more compelling.
Ericsson trades at a forward price-earnings ratio of about 16.61, which indicates that earnings for fiscal 2021 are expected to be better than last year's. The company expects top-line growth to continue for the foreseeable future, which will yield a better bottom line for the next five years. Its PEG ratio of 0.83 suggests the stock could experience a significant bull run.
In comparison, Ericsson's Scandinavian rival Nokia Corp. (NOK, Financial) trades at a trailing price-earnings ratio of 29.31. Its forward earnings multiple of 18.76 is also higher than Ericsson's, while its PEG ratio of 2.44 is well above the industry average.
In summary, shares of Ericsson appear to be relatively overvalued compared to the Peter Lynch value. When we compare it to its closest peer, however, Ericsson appears to be significantly undervalued. It could be an interesting stock to watch in 2021 as 5G rolls out.
Disclosure: No positions in the stocks mentioned.
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