The Nasdaq went through the magic 5000 last night (it closed at 5008), just 1% less than the record close of 5048.6 reached on 10 March 2000, after which the index dropped 70%. It has taken almost 15 years to get back there. The question is: are we heading for another crash sometime soon?
The tech-wreck is widely considered to have been triggered by a Barron’s article published on 20 March 2000, entitled “Burning Up”. The article quoted a commissioned study stating that “at least 51 internet firms will burn through their cash within the next 12 months”. That amounted to a quarter of the 207 companies included in their study. “Among the outfits likely to run out of funds soon are CDNow , Secure Computing , drkoop.com , Medscape , Infonautics, Intraware and Peapod.” The Nasdaq promptly fell 200 points. It didn’t help that Microsoft lost its anti-trust case a few days later, the Fed raised rates and a bunch of companies in the tech space got found out for dodgy accounting.
Of course, it wasn’t just the article, or the subsequent events. The truth is that Wall Street and Main Street already knew the truth – that there was a dotcom bubble in progress, it was just a matter of how long it would take to burst. Barron’s claim was dead accurate, but it could have been made any time in the year before the crash as well – dot com-ers needed the belief of the Street and the investing public to continue to fund the losses (the “burn rate”). And if they did, the bubble would continue to inflate. But the article helped crystallise that niggling doubt about cashflow to which everyone, it turns out, was sensitive.
An estimated US$800b of value vaporised in that crash – over half the value of the entire Australian stock market today.
(For a little entertainment, Google some of the names in the list above, like CDnow and Peapod. They still exist… but maybe in the way that it could be said that people still exist when they die and become zombies…)
Wall Street certainly did get very ahead of itself in predicting growth, which in the end didn’t come through quickly enough. But it did come through, in the end. The tech crash also resulted in the wholesale trashing of a lot of companies which are still very much alive today.
Consider Amazon. It fell from US$87 to under $6 a share. Or Apple, which went from around US$5 to US$1 a share. Google wasn’t listed then, but in 2005 it was trading at around US$60 a share, and today it is $543. The model did work, appears.
Are these companies expensive? In the case of Apple and Google, they are not.
Apple, as we noted in a column last week, is trading at a 28% discount to Telstra on EV/EBIT measures, according to Bloomberg data. The market does not believe the company can maintain its US$18b net quarter, and is pricing it as if it will deliver 60% of those earnings on a quarterly run rate. Watch out if it has another US$18b quarter any time soon.
The really big difference between now and the tech-wreck is cashflow, and plenty of it. The table below shows the cashflow multiples of the top ten NASDAQ composite companies as at last week’s close.
|Cashflow multiples of the top TEN companies on NASDAQ composite|
|Company name||Mkt cap (US$bn)||P/CF (x)|
|GOOGLE INC-CL A||371.3||16.5|
|GILEAD SCIENCES INC||155.5||15.1|
|COMCAST CORP-CLASS A||153.4||9.1|
|CISCO SYSTEMS INC||150.5||12.4|
|Total of above||2624.9|
|Nasdaq Composite Capitalisation||7580.0|
|Top 10 as % of Total||34.6%|
By contrast, consider these multiple data from 1998 and 1999 and note the following:
|NASDAQ Composite Index (CCMP) – Valuation|
|CY 1998||CY 1999||Current|
|12 Months Ending||1998-12-31||1999-12-31||2015-02-24|
- The PE ratio of the NASDAQ Composite as at 31 Dec 1999 was an eyepopping 151.6x. The number now is 30.1x.
- Price to cashflow was 33.1x back then, compared with 15.2x now.
- The all-important price/sales ratio was 4.8x, compared with 2.3x today.
Further, a lot of those measures more than doubled between 1998 and 1999 – meaning that prices certainly rose significantly, but earnings and cashflow, we now know, didn’t.
Are the not unreasonable cashflow multiples for the NASDAQ darlings of today too high? These companies are ungeared and have very significant cash. As for the burn rate, it is zero (unlike the new crop of start-ups). There is no liquidity problem anywhere in the top NASDAQ companies. So probably not.
But can we say that it’s still possible to make really significant money from listed disrupters, even after they have already gone up in price?
The question is relevant because the companies themselves are operating in areas that are subject to disruption – Google is desperately worried that Facebook’s advertising proposition, based on its much richer trove of personal data and enhanced networks, will ultimately prove more valuable that its own search.
Maybe it’s better to stick to “moated” companies like GM, Walmart and Coke – companies which have been considered to be outside the disrupt-able universe?
Except it now turns out they too have issues. Moats are being breached everywhere around us. For example, GM is desperately concerned about Tesla’s electric cars, while Coke worries about Red Bull and Walmart is under the pump from Amazon. Multiples for these companies are lower than the crop of disruption leaders, but still not low by historic standards, especially when considering the disruptive competitors with which they are dealing.
Which leaves us to contemplate our risk appetite for the flotilla of smaller companies spruiking an endless array of killer apps, social networks, big data analytics and the like. Some of these will probably crash through, and even make the cut to be bigger companies, but, actually, most don’t really seem like the sort of step change that took place in the past 20 years. And many are suffering from cash burn.
It all comes down to price/cashflow – a question which should bug every single investor every single day. Is the company in which I am investing carefully adapting its business plan to the changing world in a way which maximises long term value? And how much am I paying for the cashflow while they are doing it? Same questions for all companies. By the way, they are the questions that Warren Buffett asks every day too.
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Why is disruption working as an investment theme?03/06/2018