Op-ed: At some point, sky-high valuations will matter just like they did for the dot-com busts
- The S&P 500 has gone up by just over 68% since hitting its nadir on March 23.
- Tech stocks – including Apple, Amazon and Zoom – have driven the rally for months as consumers hunkered down amid the pandemic.
- We have also had weeks reminiscent of days nearly two decades ago when most of my top ten positions, including AOL, Yahoo, Millennium Pharmaceuticals, and Cisco, jumped by 5% to 10% each trading session.
- The drop in Cisco and other dot-com darlings could happen again to some of these new hot names, but they are a smaller part of the overall stock market today than those past bubble stars.
It's not often that celebrity home-buying sprees give me insights into the stock market.
However, when I read last Friday about Ellen DeGeneres' purchase of a $49 million house in Montecito, California, I realized that this behavior helped me understand the current exuberant state of the stock market.
It wasn't that Ellen was throwing half of $100 million on a house. It was the example of how investors buy what they want, when they want it, at whatever price is necessary, that struck me as the defining character of this current stock market.
No one can doubt that the market has been fueled by buyers on a tear: the S&P 500 is up 68% from the bottom on March 23rd.
For months, the rally was concentrated in the winners of the Covid-lockdown lottery: behemoths like Apple, Facebook, Amazon, Netflix, and PayPal; as well as upstarts, such as Zoom and Peloton, perfectly designed for a remote life.
Despite the market's ascent, that move through most of 2020 never felt like the bubble of two decades ago – back when I managed a diversified growth fund at one of the nation's largest investment complexes.
In contrast to the dot-com era, the stocks that moved the markets this year were churning out earnings at a fast clip and the upstarts were close to or already profitable.
Investors shifted course at the beginning of November, trading away from the Covid-helped darlings after the election results and the announcement of positive clinical data for the Pfizer and Moderna vaccines.
On one end of the spectrum have been the reopening stocks, including airlines, hotels, cruise lines, traditional retail, and industrial companies, rallying in anticipation of renewed activity in their operating environments.
The other stocks on a rampage are the latest technology disruptors, most of which have recently gone public, including Snowflake, CrowdStrike, Palantir, Trade Desk and MongoDB. These are primarily software companies that provide a novel way to store, sort and utilize information, often for specific industries.
One look at the near-vertical price charts of these illustrates how hot this market has been.
I have written about the surge in retail trading, a major force behind this phenomenon, especially among people for whom stock trading seems to serve as a surrogate for unavailable leisure activities.
Even hipster magnets such as dance music duo The Chainsmokers and Tony Hawk have endorsed and invested in the start-up Public.com, a social-networking site, created for small dollar and first-time traders to learn about stocks from each other.
No question, the chatter on this and other sites focuses on the big winners and why they will keep climbing.
In terms of how extended some of these investor favorites have become, we compared the number of stocks valued at over $10 billion that trade for more than ten times sales for 2021.
There are five times more stocks in that heady category now than at the close of 2018.
Some of this can be explained by declining interest rates, but speculation and yearning to participate in the upward-to-the-right trend must be a factor.
How much does this recent parabolic spike of tech names remind me of the dot-com bubble? Plenty.
We have had weeks reminiscent of days nearly two decades ago when most of my top ten positions, including AOL, Yahoo, Millennium Pharmaceuticals, and Cisco, jumped by 5% to 10% each trading session.
As illustrated below, some of the most prominent companies traded at lofty valuations that rival the darlings today.
We know what happened to the value of these stocks over the next few years – they cratered.
Cisco, one of the five most valued equities in early 2000, serves as an important example, according to George Vanderheiden, one of the smartest investors with whom I have ever worked.
Back then, the stock peaked at $79 as the poster child for strong management, with a limitless addressable market, high margins and a great balance sheet.
Despite growing earnings over 500% from 53 cents per share in 2000 to an estimated $3.25 per share for this current fiscal year, generating considerable free cash flow, and repurchasing hordes of shares, Cisco's stock, at $45 today, is down 43% over 20 years.
To George, and to me, valuation does matter and to suggest otherwise is foolish.
Cisco could never grow fast enough to justify its 2000 stock price, which was 149 times earnings.
For over 10 years, Cisco stock struggled, but it has attracted value investors during the past decade.
As George told me, "Don't forget that in technology, disruption is the name of the game, and the young, generally, eat the old."
I am not trying to ruin anyone's party, including my own, since we own several high multiple stocks whose prices we can justify by modeling out the required but achievable long-term growth rates.
However, let's not forget that a reasonably high percentage of the stocks ascending into thin air on most mobile trading apps will face new entrants with novel technology, crowd appeal, and their luster will fade.
Fortunately, at a 15% weight of the total US market ($5.4 trillion of $36 trillion), or 10% excluding TSLA, V, MA, NVDA, and INTU, this cadre of supercharged mostly technology companies is small compared to the excesses of 2000.
As a year-end wish, let's hope that if – when – they correct, they don't take the rest of the market with them.