Are Stocks In A Bubble – 28 Feb 2017

Came across this article by Economist, which is good stuff.

The article can be summarised in the chart below.

Key extract from the article:

These examine their cashflow, whether investors differentiate between companies, and whether forecasts of their future earnings suffer from a fallacy of composition. The exercise suggests that tech valuations are frothy, but not bubbling.

The first test is cashflow, and the industry passes it with flying colours. In 2001 about half of all listed tech firms were unable to convert their sales into hard dollars. Times have changed. In the past 12 months the biggest 150 technology companies generated a mighty $350bn of cashflow after capital expenditures—higher than the total cashflow over the same period of all the non-financial companies listed in Japan, for instance.

In a bubble, investors bid up the value of assets regardless of their quality. The prices of good and bad tulips soared alike in 17th-century Holland, and in 2008 subprime debt was almost as valuable as Treasury bonds. So the second test is whether buyers are differentiating clearly between tech firms, of which there are three broad types. Some, such as Samsung and Apple, are mature and profitable. At other firms, including Alibaba, Tencent, Facebook and Alphabet, sales are growing at an annual rate of over 20%, with high margins. Then there are “blue-sky” firms that are unprofitable but have explosive sales growth. Uber and Snap are examples.

One way to gauge whether investors are sensibly valuing each category differently is to calculate companies’ duration, or how much of their current market worth is expected to be realised soon and how much relies on pots of gold being found far into the future (see chart). Schumpeter has crunched the numbers for the world’s ten biggest tech firms and for three rising stars, splitting their market value into three parts: value which has already been realised in the form of net cash held, the present value of expected earnings in the next four years, and the value attributable to what happens after 2020. Samsung and Apple are not growing much but are low-risk: over 40% of their value can be explained by cash and near-term profits. The raciest firms, such as Tesla, are expected to generate over 90% of their value after 2020. These firms could well crash and burn. The good news is that investors are placing their most eye-watering valuations on a fringe of smallish companies that are growing very fast indeed.

The third test is whether there is a fallacy of composition. In a bubble the bullish claims of individual companies aren’t plausible once you add them all up. In the dotcom era the market-share targets of internet-service providers added up to well over 100%. In the subprime crisis every bank claimed that it had offloaded its risks onto other banks. The technology industry is less vulnerable to criticism on this front. The aggregate profits of the top five tech firms are expected to rise from 6% of American corporate earnings last year, to 10% by 2025: bold, but not implausible. Managers are not anticipating the same profit stream twice. For example, Facebook is not expected to become a force in search, while Google is not expected to conquer social media.

IMO, there is a critical flaw in the above viewpoint. Shouldn’t tech companies be differentiated between those that charge for their products/services vis-a-vis companies offering their service for free, whereby the users are its products? I believe the type of value analysis mentioned in the article should apply to companies which offer a product/service for a fee. Then an objective analysis could be done to determine future growth potential based on meeting un-met consumers needs, or potential to create new needs in consumers.

For the group of companies that offer their products/services for free, and count its registered users and personal profile information as its products/services, it is primarily in the advertisment industry to sell “consumer attention”, or consumer identities/insights. Last checked, global advertising revenue was estimated at $547.37 billion in 2017. This piece of pie is definitely not all digital, thus let’s assume half is for digital (need someone to do the work here for breakdown between web/mobile vs others). That’s about $273.5 billion available for everyone to grab.

Google being the No.1 undisputed digital marketing juggernaut has a market cap of $579 billion today, with Facebook at $395 billion owning the social front. Put together, their $974 billion market cap would swallow most of the digital advertising revenue. So which part of the revenue stream are tech unicorns supposed to invade (hint, IPO or get acquired)? – By the way, every tech unicorns counts XXX engaged users. Are there really so many users who are snapping pictures, posting pictures or just wasting their lives? Who’s checking for double count?

Which leads me to my totally unscientific and bias view. I believe we should view the current trend in tech stocks as one driven by “subprime” venture capital (i.e throwing money at any !@#$ without the rigor of early angel investors during the 2010 – 2013/14 era). What is fueling this subprime venture capital? Ample credit and liquidity, which is available only to a few ($12 trillion of QE as of June 2016). The cheap money flooding the financial system has created a tech bubble and inflated the worldwide stock exchanges, which refused to recede since no one is calling in the loans (The Fed sets employment targets, then shifts its position) yet. But history has taught us, once the loans are called, things could turn ugly very quickly.

Snap, a tiddler with $400m of sales and $700m of cash losses in 2016, is expected to list shares on March 1st that will give it a valuation of over $20bn.

In the first quarter of this year, Uber lost about $520 million before interest, taxes, depreciation and amortization, according to people familiar with the matter. In the second quarter the losses significantly exceeded $750 million, including a roughly $100 million shortfall in the U.S., those people said. That means Uber’s losses in the first half of 2016 totaled at least $1.27 billion. – https://www.bloomberg.com/news/articles/2016-08-25/uber-loses-at-least-1-2-billion-in-first-half-of-2016

It is scary sometimes when you think about how so many smart people can go along with the party. When the music stop, who’s holding the !@#$? – Every “expert” or analyst on the media will claim its inevitable and saw it coming…

The people earning a honest living with a regular salary, saving, and looking forward to retiring will be wondering, “What happened again?” (By the way, $1.27 billion is $1,270 million, and $12 trillion = $12,000 billion = $12,000,000 million). The elites will come out and say if the tech bubble burst, the economy will suffer and destroy jobs. Time for bailout.

Modus Operandi – Create, Hype, Inflate, Propagate, Distribute, Extract, Crash, Repeat.

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