Investors sometimes pay a high price for lofty expectations. A good example of this can be found in the number of companies trading at over 15x sales.
Since 2000, an average of 181 companies traded at over 15x sales in any given week (with a minimum $100 million market cap and not trading OTC).
Today that number hit 600. The last time we saw numbers remotely close to this was 2000 when it peaked at over 400 companies.
Which likely explains why people keep comparing the Dotcom Bubble to today. While many things are different today than back then, history allows us to compare how people acted across similar situations.
What isn’t different is investor behavior. Rampant speculation was largely concentrated in telecom and internet stocks in the Dotcom Bubble. Today, it’s less concentrated but still exists. Comparing those 600 companies, we get a mix of new and old, spread across several dozen industries. Which explains the pockets of speculation today.
The stories told around these companies are also the same. Many have a limitless future if we are to believe it. They’re certainly priced for it.
Over half of the 600 stocks trade at over a $1 billion market cap, roughly 20% are over $10 billion, and a handful exceeds $100 billion (3 are over half a trillion). Yet, 80% of these companies have no earnings, 64% are projected to have no earnings over the next 12 months, and the group carries a median Price/Sales multiple of 36. The companies that do have earnings carry a median P/E of 83.
To be fair, some of these companies are still suffering from last year’s meltdown. They were hit hard and have yet to see sales recover. The market is pricing in an imminent recovery to past sales numbers. Their multiple will gradually fall, all else equal, if sales return to normal over the coming quarters.
As for the rest, maybe a few live up to the stories, the growth expectations, and go on to greatness. History suggests most investors will be disappointed. The reason is simple. The problem with pricing companies so high is they actually have to meet expectations to be worth it. For investors to make money paying the current high stocks prices, companies must exceed expectations.
In reality, there’s no room for error when companies trade at extreme prices. Execution has to be perfect. One slip up from management or one bad quarter can change the story, give investors cold feet, and send the stock tumbling. The reality is most companies never live up to the hype.
There’s a reason Ben Graham required a margin of safety. Humans are fallible. Management and investors alike make mistakes. The future is hard to predict. Pricing in a little room for error goes a long way in avoiding losses.
But when rampant speculation leads investors to pay extremely high prices for stocks, the long-run returns can be devastating. In fact, a portfolio holding a basket of stocks (with at least a $100 million market cap) exceeding 15x sales lost money from January 2000 to today. What’s worse, it suffered a 92% drawdown! Not many investors can recover from that.
Of course, maybe this time is different. Maybe valuations don’t matter. But history suggests otherwise.
Markets are driven by stories in the short run, after all, but in the long run, investors eventually want to see results. The question is always when. Until then, investors should take a lesson from the Dotcom Bubble: these periods can drag on longer than we think.
- The Long and Winding Road to Wealth – Compound Advisors
- There’s A Way You Can Beat The Best Investors. You’ve Just Got To Know When To Sell – NPR
- Other People’s Mistakes – M. Housel
- A Vital Characteristic of Successful Investors: Grit – Klement on Investing
- Inflation: What Does the Academic Research Say? – Man Institute
- Richard Thaler: When Somebody Would Fire Us, It was Almost Always at Exactly the Wrong Time (podcast) – Meb Faber Show
- Coins, the Overlooked Keys to History – The New Yorker
- The Lost History of the Electric Car – Guardian