"When investors forget the fundamentals and follow fashion or hype, it often does not fare well."

In our last blog, published on 1st May, entitled “Complacency Rules OK”, we said that investors appeared to be complacent that markets would be subdued and volatility remain at very low levels.

That was two weeks ago, and as the chart below shows, volatility as measured by the CBOE Volatility Index, known by its ticker symbol VIX, has now returned to more normal levels.

Source: Bloomberg LP

The Uber flotation this week should remind investors of the dangers of investing in tech stocks generally, and perennially loss-making tech stocks specifically.

The shares have recovered part of their initial falls but are still more than 8% below their issue price (the company is still valued at $69 bn after the fall and is forecast to lose c. $4bn a year for the next few years:

Source: Bloomberg LP

Uber Technologies Inc, Estimated Net Income, GAAP

Source: Bloomberg LP

Interestingly, Morgan Stanley offered its elite clientele a chance to invest in Uber as long ago as 2016 at a price of $48.77 vs the $41.29 closing price on 15th May 2019.  Uber has managed to reach these dizzy heights by being labelled as a tech stock rather than a transport stock, and be seen as a disruptor to the industry even though it is really cross-industry as not only does it have to compete with taxis, public transport, but other companies with their own ridesharing services e.g. General Motors, Tesla and Google.

A sensible way of looking into the level of the madness in some of these tech stocks is to see how they compare with their old fashioned (but much larger peers).  For example, General Motors (GM) has a market cap of less than Uber, $53 Bn even though it is forecast to have revenues in 2019 of $146 Bn, profits (Net Income, GAAP) of $8.4bn, and pays a dividend to its shareholders.  It also has a self-driving subsidiary called Cruise that recently raised £1.15 Bn valuing it at $19 Bn.

Even, the investment guru, Warren Buffett appears to have caught the tech bug, recently buying a $900m stake in Amazon. The Company appears to satisfy the Buffett “moat” credentials – “So we think in terms of that moat and the ability to keep its width and its impossibility of being crossed as the primary criterion of a great business.” 

However, in terms of the Buffett “intrinsic worth” principle, I find it hard to understand how a company that already stands on a multiple of 69x its 2019 earnings per share, 14x its book value, and 22x its cashflow would be at a significant discount to its intrinsic value.

When investors forget the fundamentals and follow fashion or hype, it often does not fare well.

For example, in the UK it was just a year ago when Aston Martin floated, helped by James Bond nostalgia and hype, enabling a high valuation for a Company that had managed to just turn its first annual profit since 2010.  The shares have fallen more than half since it floated, but then its earnings expectations have fallen dramatically too:

Source: Bloomberg LP
Source: Bloomberg LP

What does this tell us? Apart from the fact that following hype and fashion can be very expensive, it also tells us that maybe the recent surge in tech stocks and valuations is reaching a crescendo.

In the US, tech stocks have now reached almost their pre-2000 peak in terms of performance:

Source: Bloomberg LP

Although, to be fair much of the performance has been due to higher growth in revenues, earnings and cashflow.  There are some signs that these are slowing partly as various markets mature and partly a function of size – for example, Google’s operating profits are forecast to grow by 31% in 2019, then 20% in 2020, then 15% in 2021.

All this may explain why value stocks have fared so badly in recent years and why so many value driven fund managers appear to be giving up.

In my experience, when a fund manager throws the towel in an asset class, region or type of stock that often marks the bottom – the chart below shows that since June 1989 a global basket of growth stocks have outperformed value stocks by 125% and that the ratio of a value index is now back to the relative levels last seen close to the tech peak, in early 2000:

Source: Bloomberg LP

At SCM, over the last 12 months, we have increased our tilts within our portfolios to these out of fashion, value stocks. We try and take advantage of opportunities rather than give up on them.

 

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