Portfolio manager
Anyone who was investing in the period 1997 to 2000 will have their own memories of the extremes of the dot.com madness. For those of us in the UK, one of the defining moments was the IPO of lastminute.com, the first major British internet company, where the share price leapt from 380p to 511p in its first hour of trading, valuing a company with quarterly sales of just £409k at £768m. Two weeks after listing, the share price had dropped to 270p and by Monday, 17 April 2000, lastminute.com was trading at 30% of its flotation price. The story of Boo.com was told in the book Boo Hoo: A Dot.Com Story from Concept to Catastrophe. The company launched in the autumn of 1999 selling branded fashion apparel over the Internet and spent $135m of venture capital in just 18 months before being placed into receivership on 18 May 2000 and liquidated. In the US, older investors will remember Webvan which raised $375m when it went public in 1999, valuing it at almost $5bn and was bankrupt two years later or Pet.com which went public on NASDAQ in February 2000 and raised $82.5 million but was bankrupt by November of the same year.
As crazy as these stories sound, recent events in the US might have surpassed the extremes of 1999 raising the question of whether this is the craziest growth stock bubble ever.
Source: Bloomberg 17 December 2020. Past performance is not a guide to the future. The price of investments and the income from them may fall as well as rise and investors may not get back the full amount invested
A glance at the vertical line in the chart above which shows the remarkable ascent of NASDAQ in the last couple of years should immediately alarm investors. In addition, looking at long run valuation multiples, it is hard to escape the conclusion that growth stocks are very expensive. In fact, using the price to sales multiple in the chart below, they are more expensive than they were at the peak of the dot.com bubble and we know how that ended; by 2002, NASDAQ was trading at a quarter of its March 2000 level. Clearly investors are betting that this time will be different.
Sources: GMO, Worldscope, Compustat, MSCI. As of 30 Sep ’20. Note: Valuation ratios calculated using a weighted median.
Some have argued, however, that what differentiates expensive valuations from a bubble is behaviour. Jeremy Grantham, co-founder of US investment firm GMO, says that what true investment bubbles have in common is a mania on the part of market participants and a sense that if people would only jump on board, “Everybody Ought to be Rich.” With that in mind, lets look at a few examples of speculative behaviour that suggest this is a true bubble.
Tesla has risen some 685% in 2020. In an excellent new paper by Rob Arnott[1], the author demonstrates how implausible the assumptions baked in to Tesla’s $608bn valuation are.
‘What else could we buy with $608 billion? Let’s consider the Electronic Vehicle (EV) market. Renault-Nissan, Volkswagen, and Hyundai-Kia are the second, third, and fourth largest EV producers with 13%, 11%, and 8%, respectively, of EV market share.6 Combined, these three organizations are responsible for 32% of EV market share, about 10% larger than Tesla (and growing roughly as fast), but together are valued at $172bn, barely one-fourth of Tesla’s value. Of course, these entities produce a lot more than just electric vehicles. The equivalent of Tesla’s current valuation can buy not only all of the electric vehicles these three organizations sell (actually 10% more than Tesla produces), but also about 27m of the non-electric vehicles they sell each year, close to 60 times Tesla’s likely 2020 EV sales, with $436bn to spare!’
Source: Bloomberg 17 December 2020. Past performance is not a guide to the future. The price of investments and the income from them may fall as well as rise and investors may not get back the full amount invested.
In their latest quarterly letter[2], GMO’s Ben Inker and John Pease, highlight the absurdity now apparent in some stocks using the example of Nikola which reached a valuation of $30bn on an infinite price to sales multiple since it had never actually produced anything and hence had no revenue let alone profits.
Source: Bloomberg 17 December 2020. Past performance is not a guide to the future. The price of investments and the income from them may fall as well as rise and investors may not get back the full amount invested.
This spring a would be Tesla called Nikola went public via a reverse merger with a SPAC9 at a valuation of $3bn. In the 2020 EV frenzy, it rose 10-fold to a market cap of about $30bn. This company is a rare bird in the stock market, a pre-revenue manufacturing company. In fact, Nikola is not only pre-revenue, having never sold any having never sold any vehicles because it has never produced any vehicles . Further, it has not even built the factory in which it aspires to build the trucks that it has yet to sell. This summer, a report came out detailing allegations that almost all of the claims of Nikola’s Elon Musk wannabe founder over the few years of its existence were lies. That founder, Trevor Milton, was forced to resign and the company has yet to meaningfully refute any of the claims made in the report. The stock duly fell, but even after information came out showing that pretty much everything the company has claimed to accomplish in its history was a lie, it still has a market cap more than three times its value at its public debut less than a year ago – a valuation that was presumably predicated on the company’s claims actually being true.’[3]
Other signs of excess in growth stocks[4]
Source: Bloomberg 17 December 2020. Past performance is not a guide to the future. The price of investments and the income from them may fall as well as rise and investors may not get back the full amount invested.
A recent article in the New York Times highlighted how crazy things were in private markets as well as public:
‘SAN FRANCISCO — Hopin, a virtual events start-up in London, had seven employees and was valued at $38 million at the beginning of the year. Johnny Boufarhat, the company’s chief executive, wasn’t planning on raising more money.
But as the pandemic spread and more people held virtual events, Hopin’s business took off. Unsolicited offers from investors started pouring in. “It’s like a drumbeat,” Mr. Boufarhat said. “That’s become the new way for investors to tempt founders.”
In June, Hopin raised a fresh $40 million from venture capital firms such as Accel and IVP. Last month, without even building a formal presentation, the company garnered a further $125 million, valuing it at $2.1 billion — a 77-fold increase from a year ago.’
New York Times, 7 Dec 2020
There are all sorts of theories about why the valuations of growth stocks are being driven to historically elevated levels; central banks money printing certainly helps as does a generation of people with time on their hands due to lockdown and an ability to trade commission free from their smartphones. The historical precedent is that these episodes end badly for those who get caught up in them and I see little reason to see why this time will be any different.
[1] Tesla, the Largest-Cap Stock Ever to Enter S&P 500: A Buy Signal or a Bubble? By Rob Arnott,Vitali Kalesnik,Lillian Wu December 2020.
[2] Value: If not now, when by Ben Inker and John Pease, GMO, Dec 2020.
[3] Value: If not now, when by Ben Inker and John Pease, GMO, Dec 2020.
[4] The following bullet points are sourced from Bloomberg 9th December 2021.
The statements and opinions expressed in this article are those of the author as of the date of publication, and do not necessarily represent the view of RWC Partners Limited. Past performance is not a guide to the future. The price of investments and the income from them may fall as well as rise and investors may not get back the full amount invested. This article does not constitute investment advice and the information shown above is for illustrative purposes only and should not be construed as a recommendation or advice to buy or sell any security. No investment strategy or risk management technique can guarantee returns or eliminate risks in any market environment
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