Photo Credit: Steffen Ramsaier, Flickr Creative Commons
By Jason Zweig | 5:03 pm ET Apr. 23, 2015
Investors weren’t wrong; they just paid too much to be right.
That’s the lesson of the Nasdaq Composite Index’s 15-year slog to surpass the record high of 5048.62 that it first set on March 10, 2000. Before you get too excited over the booming stock market and Thursday’s new Nasdaq high, make sure you aren’t repeating the mistakes of the past.
Back in late 1999 and early 2000, investors were so infatuated with how technology would transform the world that they were willing to pay any price and bear any burden to buy stocks connected with the Internet and telecommunications.
By March 10, 2000, Yahoo Inc.’s stock was trading at 1,781 times the 10 cents per share of net income the company had generated over the previous 12 months. That day, Yahoo had a total stock-market value of $93.7 billion—50% greater than Warren Buffett’s Berkshire Hathaway Inc.
That same day, Cisco Systems Inc. had a total market value of $467 billion, behind only mighty Microsoft Corp., and traded at 187 times its earnings over the previous year. VeriSign Inc., an online-security company, traded at 7,998 times earnings; Ciena Corp., the networking company, at 4,072 times; Rambus Inc., the semiconductor manufacturer, 1,138 times.
Over the long term, the S&P 500 index of major stocks has traded at an average of about 16 times the earnings of the underlying companies. Was it worth paying dozens or hundreds of times more than that to become an owner of the companies with the greatest growth prospects?
Of course not. According to AJO, an institutional money manager in Philadelphia, since March 10, 2000, the S&P 500 has generated an average return of 4.78% annually; the Russell 3000, a broad measure of U.S. stocks, 5.12%. But the Nasdaq Composite, dominated by the tech stocks that were so overvalued in early 2000, has returned 0.99% annually. All these returns include dividends.
The companies for which investors’ hopes were highest ended up delivering the returns that were lowest.
“We were all directionally correct, but we got carried away,” says Paul Johnson of Nicusa Capital, a financial-advisory firm in New York. Fifteen years ago he was one of the most prominent boosters of technology stocks as an analyst at the tech-focused investment bank Robertson Stephens.
“Almost everything we thought would happen turned out to be correct,” he says. The Internet grew to dominate daily life and mobile telecommunications became universal.
But the total market value of Cisco’s stock has fallen by two-thirds since March 2000. Yahoo has lost more than half its total market capitalization. And the Nasdaq Composite delivered half the return of U.S. Treasury bills.
That’s what happens whenever investors overpay for excitement. It’s why people who invested in Japan in late 1989, when stocks there were trading at 54 times earnings, still haven’t broken even. It’s why investors who bought U.S. stocks at the peak of the 1929 bull market lost more than 80% of their money in less than three years.
In 2000, the euphoria was limited primarily to technology, media and telecom stocks, and today it’s focused on social-media and other stocks connected to the “sharing economy.”
“We’ve gotten back to theme investing,” says Mr. Johnson. “The phraseology is different, but the rationales are the same: The sharing economy and social networks will free up excess capacity and drive productivity higher.”
In the six months since October, the total implied valuation of the private companies in The Wall Street Journal’s “Billion Dollar Startup Club” rose from $196.9 billion to $331.6 billion—a 68% gain.
Just in the past few weeks, Pinterest Inc., the privately held online scrapbook, has raised funding that gives it a hypothetical value of $11 billion; Lyft Inc., the ride-sharing service, picked up another $530 million in venture capital for an implied valuation of about $2.5 billion; and Uber Technologies Inc., the ride-sharing service, has driven past an estimated valuation of $41 billion.
At that level Uber is valued at about 100 times its estimated revenue in 2014, or about 50 times higher than the equivalent price-to-sales ratio for the S&P 500.
Many of the public companies investors are most excited about don’t have net profits; they have rapidly growing sales and even faster-growing hopes. Just as in 1999 and 2000, “there’s no discussion about fundamental value,” Mr. Johnson says. “The discussion is all about growth potential.”
But, he adds, “growth will not save you if you overpay.”
Mr. Johnson knows whereof he speaks. As a self-described “voracious bull,” he touted stocks like Cisco and Sycamore Networks Inc. in 1999 and 2000. Sycamore’s shares have fallen 99.8% since March 10, 2000.
In 2005, a federal jury found that Mr. Johnson had failed to disclose in his research reports that he had a financial interest in mergers involving private firms being acquired by public companies he covered. He was later ordered by the Securities and Exchange Commission to give back $2.2 million in profits and penalties.
Mr. Johnson concedes the charges but says, “I believed in my recommendations and didn’t sell until the very end, when the bust was hitting terminal velocity on the way down.” He later ran a hedge fund specializing in cheap stocks, not expensive ones, and now teaches investment valuation as an adjunct professor at Columbia Business School.
Those who bought technology stocks in the boom lost nearly every penny they put up. Those who bought during the bust, or who built positions patiently over time, profited.
The sharing economy of early 2015 is no different than the “new economy” of early 2000: It will almost certainly turn out to be a huge boon for businesses and consumers. But it will wipe out investors who think no price is too high to participate.
Source: The Wall Street Journal