Mad Money

Cramer: Watch out—Micron's stock may not be as cheap as it looks

Key Points
  • "Mad Money" host Jim Cramer uses the stock of Micron to explain why low price-to-earnings multiples don't always signal good value.
  • Cramer recalls a similar situation at Bethlehem Steel, a company that ceased operations after analysts overshot the earnings estimates.
Micron may not be as cheap as it looks

Of all the technology sector's battleground stocks, CNBC's Jim Cramer has found the stock of Micron Technology to be the most controversial.

"After all, when a semiconductor stock sells at less than five times earnings, your thinking is that it represents a tremendous bargain — how could it not?" the "Mad Money" host said.

But after 25 years of following and analyzing Micron, Cramer wasn't so sure about that theory.

"I know that it's at its most vulnerable when it sells at its lowest price-to-earnings multiple," he said. "That's a signal. That could be the market telling you — could be — that Micron's much more expensive than it appears as those earnings estimates ... won't be reached."

For example, if Micron's actual earnings results turn out to be 50 percent lower than analysts expect, that would mean Micron's selling at 10 times earnings instead of five.

Cramer acknowledged that Micron's multiple as been low for a while. The price of dynamic random-access memory (DRAM) chips, Micron's leading product, has long "defied gravity" thanks to rising demand for personal computers, tablets and other devices, Cramer said.

But Micron's second key business, flash memory, has been flooded with a lot of excess inventory, which has led to falling prices.

"Now, here's the deal: I don't want Micron the stock to go down. I don't. I want it to go up. You might own it," Cramer said. "I'm simply warning people that it might not be as cheap as it looks."

The "Mad Money" host pointed out that Facebook's stock is in a similar boat: it trades at less than 19 times next year's earnings estimates, which is cheap considering its 40 percent growth rate. If the earnings numbers came down, though, shares of Facebook would become more expensive.

"Everyone seems to understand that's a possibility with Facebook, so it is a little odd that so many people have trouble grasping the same concept when applied to Micron," he said.

Cramer's concern stemmed from his recollection of an analogous situation at Bethlehem Steel, a now-defunct company that was once the second-largest steel producer in the world.

In the late 1980s, before it hit a wall of high debt, a bad product spread, an overpaid workforce and a lack of demand, Bethlehem Steel was insanely profitable, Cramer said.

"There was a moment when Bethlehem Steel's profitability was rising so fast, so strong, that it looked like the stock was selling at just two times the next year's earnings estimates," he said. "Some of the most important steel analysts were telling me, 'Listen, you simply have to buy it.' What could go wrong with a stock selling at two times earnings?"

As it turned out, a lot could go wrong. In just two years, Bethlehem Steel was losing money, under pressure from a strong dollar and other countries dumping steel in the United States. Ultimately, the company went under in 2003.

"Micron's a much better company than [Bethlehem Steel] ever was," Cramer admitted. "That's not the point. All I'm concerned about, all I'm trying to do is teach people the fallacy of the idea that stocks are always a good value when they have a low price-to-earnings multiple. That's not true, as an excessively low multiple often signals an imminent earnings collapse."

"And while I hope DRAM prices stay strong, and I hope flash memory prices can rise back up, I mainly just don't want anyone who watches this show to lose money," Cramer continued. "That's my only dog in this whole Micron hunt."

WATCH: Cramer's warning about the stock of Micron

Cramer: Watch out—Micron's stock may not be as cheap as it looks

Disclosure: Cramer's charitable trust owns shares of Facebook.

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