Last week I broke my silence about the irrational action I've witnessed in the Nasdaq Composite Index (QQQ). My article followed what I believed to be a questionable acquisition of Whatsapp, a $19 billion deal that took place after Rakuten's acquisition of Viber, a great comparable, for only $900 million. Adjusting Rakuten's price paid per Viber user to that of Whatsapp's users would show that Facebook (FB) paid north of a 90% premium to acquire Whatsapp. While I believe that Facebook genuinely wanted to acquire Whatsapp, I also think that the firm was desperately searching for ways to park its stock's recent irrational gains AOL (AOL) Time Warner (TWC) style.
In my article, I noted that the Nasdaq, which has traditionally moved in line with the S&P 500 (SPX) since 1994, has been on an unexplainable tear ever since 2009! In fact, if you placed your money into the Index in 2009, you'd be up 200%, or gains of 40% per year! During that period, the S&P returned 144%.
Even since last week, the stocks I cited as belonging to the "bubble" group continued to increase in market capitalization by an additional 3% on reports of hope and vision, while the value stocks with real earnings, real returns, and real global infrastructures actually declined by 1%!
Is this rational?
Before I answer that question, I'd like to first turn to Robert Shiller's Irrational Exuberance. In the following section of the book, he refers to the difficult-to-explain stock prices of the S&P companies in 1999:
The extraordinary recent levels of U.S. stock prices, and associated expectations that these levels will be sustained or surpassed in the near future, present some important questions. We need to know whether the current period of high stock market pricing is like the other historical periods of high pricing, that is whether it will be followed by poor or negative performance in coming years. We need to know confidently whether the increase that brought us here is indeed a speculative bubble - an unsustainable increase in prices brought on by investors' buying behavior rather than by genuine, fundamental information about value. In short, we need to know if the value investors have imputed to the market is not really there, so that we can readjust our planning and thinking.
So I ask, has the behavior in the Nasdaq markets since 2009 been brought on by genuine, fundamental information about value or has it been driven by hope and vision, or perhaps unsustainable actions of momentum traders?
As I discussed in my previous article, I believe the Nasdaq is currently being led by two groups of stocks -value and growth stocks. To show just how diverse the two groups are (and to respond to criticism that my selection in the previous article involved some sort of bias), I've decided to break down the entire Nasdaq 100! Though I also looked at the entire Nasdaq Composite Index, I made a decision to stick to the Nasdaq 100 for simplicity. While my analysis showed that the Nasdaq 100 is trading at significantly more rational levels than the Nasdaq Composite Index (which is closer to 2,500 stocks and a P/E of 31X) my point should still be evident, even through the observation of the smaller Index.
My findings are as follows:
Unlike the prior Nasdaq bubble, which was easier to detect as all stocks were trading at irrational levels, the current irrational behavior is more difficult to identify. The reason? The irrational P/E ratios of the growth stocks are disguised by the unreasonably low P/E ratios of the value stocks.
Even the below table masks the serious nature of the irrational betting taking place by investors on companies that do not yet have sustainable business models. The differences appear much more serious between the two groups in the Nasdaq Composite Index.
Among the Nasdaq 100, only 29 of mostly mega-cap stocks traded below the Index P/E and 71 traded above the Index P/E .
Despite the fact that the 29 value stocks, including Apple (AAPL) and Microsoft (MSFT), are out-earning their 71 growth peers by a 3-to-1 margin, these value stocks only have 75% of the market capitalization value of the growth stocks' market cap, as evident in the table above.
Some of the biggest offenders? Facebook, Amazon (AMZN), Netflix (NFLX), Tesla (TSLA), and even Google (GOOG)!
I'd like to revisit some of these growth stocks to better observe what we've witnessed in their behavior and how analysts react to that behavior.
Amazon
During the past five years, Amazon has advanced by +458% and despite having one of the weakest fundamental frameworks, Amazon continues to hang on to its rich valuation. A few months ago, a writer here on Seeking Alpha wrote this about Amazon:
"If you believe, as Amazon management does, that the future growth is going to be there for Amazon, then you ignore the current P&L and think about what a future P&L might look like."
The writer continued:
"So when you read that a company is losing money, don't read that as a bad thing. It could be a very good thing. It all depends on why."
"Believe", "Ignore", "Future"...
Such an approach is of course a dangerous way to gauge a company's success.
Amazon has now for years heavily invested in infrastructure, warehouses, equipment, R&D, etc. At what point will the "future" arrive? Analysts believe that Amazon's 2015 price to earnings ratio will drop to 82X from its current 600X. Despite 80X being an absurd amount to pay for a developed mega cap company in general, given the Firm's operating margin issues and their fierce battle in such a competitive environment, I am not so sure they can even achieve that.
Tesla
To reiterate just how irrational this stock might be, this week, an analyst painted a fantastic image of what a future Tesla might look like! He described a Tesla plan that would lead the automaker towards a "utopian society" by 2028 (that's 14 years from now)!
His actions reminded me of those incredible days in 1998 when analysts were predicting that AOL would one day take over the Internet.
This projection should be considered irrational and highly reminiscent of "that other era" by anyone's standards. It's as if we live in a world free of risk, recessions, political movements, and competition.
Google, Facebook, & Advertising
Shocking as it may seem, Google earns only 35% of what Apple earns, mostly on advertising revenue. As I've previously argued, having that one ad revenue as the only major source of income is dangerous as it heavily relies on the power of ad suppliers and their business spending decisions. That is the case even if we do love spending time on all of those wonderful Google products.
Additionally, serious competition for advertising dollars will be a very serious threat to Google's current business model in the future.
One company that could be a fierce rival? Facebook, another constituent trading at irrational prices.
After adding $100 billion and +146% to its market cap gains just this past year, I would expect Facebook's investors to be more cautious that the gains have come slightly faster than expected. Instead, investors appear to be confident that Facebook is just getting started.
Conclusion:
While investors continue to bid up prices - irrationally - to levels we should only see years from now, good value still remains among certain Nasdaq stocks. Investors who consider the benefits of owning strong stocks - like Apple - that do not move so much as a result of dreams and hopes, but rather as a result of actual proven performance and real earnings, might not be generating short-term gains as quickly these days as their bubble-contributing rivals, but their portfolios are also not sitting at the considerable risk-levels waiting for this thing to explode.
Please message me with any questions or feedback.
Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. This article represents my views only and not the views of any company that I am affiliated with. This article is intended for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation, or endorsement to buy or sell any security or private fund. (More...)
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