Clive Hale

Clive has been involved with the investment industry for over 40 years as a fund manager, funds researcher, non-exec director, investment co

Dec 30, 2020
2 min read

To say that low interest rates justify high valuations in stocks is also to say low interest rates justify low future returns in stocks. If one wishes to protect overvalued prices, one also has to accept meagre long-term returns.

~ John Hussman (@hussmanjp), Hussman Funds

There have been some remarkable suggestions to justify valuations and the “low interest rate high valuation” gambit is taken as gospel by many. However as the Irishman said when asked for directions, “I wouldn’t start from here”…

The FAANGs have now been joined by Zoom and Tesla the latter having just been admitted to the S&P 500 thus begetting even more “passive” (of thought?) buying. Here are the latest valuation metrics courtesy of David Collum whose “Year in Review” is his annual magnum opus and well worth a read albeit a very long one.

Apple. After hitting the almost unimaginable $1 trillion market cap in 2018, Apple

romped past the $2 trillion mark less than a year later, exceeding the market cap of the entire Russell 2000.ref 17 It was jacked by $400 billion in ten trading days. Apple’s p/e ratio doubled since the start of 2019 (16 to 32), attaining its highest valuation in history. Over the preceding five years earnings had increased 16% total—2.9% per annum—on revenue growth of <25% total (<4% per annum). Apple’s five-year sales growth rate was just 4.1%.ref 20 Their product line suggests that they replaced Steve Jobs with John Sculley again.#

Microsoft. The stodgy old lady of tech sits at 35 times net income with a sustainable 6.5% per annum nominal earnings growth over 8 years. The rest of their 600% capital gains over that same period was valuation expansion.

Amazon. The Bezos dynasty has racked up a 1,000% return in 6 years. Wow. Just thinking out loud, Amazon is a great company, but at 150 times net income and >80 times free cash flow, it reminds me of that $300,000 Honda Civic. Here’s a gedanken experiment: if you

completely unwind that 1,000% gain by collapsing its share price by 90%, you’d have a p/e ratio of 14.

Netflix. NFLX has risen 100-fold in a decade. That is hard to argue with, but it is priced at

>100 times net income and 10 times revenue after having borrowed $11 billion during the last 5 years to create new content. They are losing money or, in the vernacular, there’s no ‘F’ in earnings. The creation of content is not like building a nationwide rail system. That beast needs to be fed continuously. Do they mooch another $11 billion? Are there any potential customers left who have not discovered Netflix? Now imagine unwinding this 100-bagger completely— dropping the share price by 99%. They would still be losing money and would also lose access to the credit markets. My brain hurts.

Nvidia. Having rocketed 2,000% in five years and >100% this year alone, this FAANG designated hitter sports a p/e of >100, price-to-book of >20, and price-to-revenue (or sales) of 25-ish. These were crazy-high numbers even for the dot-com era. The appeal must be the 0.12% dividend and a strong pay-out ratio.

Facebook. Stockman notes this >$800-billion-dollar deep-state investment is not on the surface crazy at 30 times free cash flow. But their low single-digit earnings growth facing the biggest impending plunge in advertising revenue in modern times seems ominous. Neither online advertising nor demand for scraped data is unlimited. I suspect—admittedly it’s only a hunch—that some of their earnings come from governments’ interest in scraped data. That many of us think the world would be a better place if Facebook completely disappeared is also a concern.

Google. Sitting at a $1.2 trillion market cap, a price-to-earnings ratio of 35, and two years of flat earnings owing to that rumoured advertising crunch, Google seems expensive. It is yet another data scraper cannibalizing each other’s revenue streams, but you should listen to the more learned individuals on this one. What I can tell you is that you can aim a digital warhead directly at my frontal lobe, but I am still only buying one mattress and only when I need it. Data scraping is cool but it seems like just smarter advertising to me.

Zoom. Skype gave up a 35:0 lead to Zoom, which tacked on 800% as of October before dropping back to a net 500% gain. (They were pikers compared with Carver Bancorp, which tacked on 800% in one day.) Zoom, with revenues in the $1–2 billion zone, is now considered more valuable than Exxon-Mobil with revenues topping >$200 billion. When will a better conferencing software be developed by some Stanford graduate student? I also wonder what data is being scraped? What is the market price (and who would pay it) for conversations of stodgy old bastards talking about their business plans?

Tesla. The granddaddy of all bubbles is Tesla. By every metric, the investing world has lost its mind. Yes, their cars are cool. Give them points for having the first and only self-igniting car on the road and for not needing commands from the driver to accelerate markedly. They put up four quarters in a row of fake profits by selling gobs of government-granted carbon credits for cars not yet sold. Tesla controls about 0.5% of the global car market in 2019 (last full year) while sporting a market cap that is larger than the entire US and European auto sectors.

Tesla’s metastable and metaphysical p/e ratio of 1,240 means investors are paying $100,000 to buy $82 of annual earnings. This is like buying a 10-year treasury but with a tad more risk. It is said that “TSLA is not being priced to perfection… it’s being priced to impossibility.” Its market cap popped $64 billion in one day, which corresponds to $200,000 per car sold last year. (Face in palm)

And to conclude some relevant quotes from the great and good.

Markets are strongest when they are broad and weakest when they narrow to a

handful of blue-chip names. Ie the FAANGs

~ Bob Farrell’s Investing Rule #7

For sale. Hedge. Never used.

~ 2020 Bubble of Everything, The Shortest Story

A mania first carries out those that bet against it and then those that bet with it.

~ Jim Rogers

This will end badly….I have been completely amazed. It is a rally without precedent…the only one in the history books that takes place against a background of undeniable economic problems…the market and the economy have never been more disconnected…the current P/E on the U.S. market is in the top 10% of its history… the U.S. economy, in contrast, is in its worst 10%, perhaps even the worst 1%…. This is apparently one of the most impressive mismatches in history…after a 10-year economic recovery, this would have been a perfectly normal time historically for a setback….And then the virus hit…bankruptcies have already started and by year-end thousands of them will arrive into a peak of already existing corporate debt…the history books are going to be very unkind to the bulls.

Jeremy Grantham

The stock market has returned more than 125% since the 2007 peak, which is roughly 3x the growth in corporate sales and 5x more than GDP.

~ Lance Roberts (@LanceRoberts), chief Strategist RIA Advisors

I understand people who bet on moral hazard. I understand people who bet on the Fed backstop. I don’t do it. I don’t think that’s a good way to invest…This notion that it doesn’t matter what happens to fundamentals…It doesn’t matter what happens to corporate earnings… It doesn’t matter what happens to economic growth… because The Fed will buy what I want to buy… that’s the mindset of the market right now….Why has the fed continuously conditioned markets to expect them to step in and repress any volatility? Isn’t it time to stop doing that because you end up not only undermining the system itself but you undermine the credibility of an institution that is critical to the well-being of this and future generations?

~ Mohamed El-Erian (@elerianm), former manager of Pimco

The price you pay determines your rate of return.

~ Warren Buffett