How to uncover true potential
Friday, 6 September 2019
By Bernd Struben
- The stocks that set trends…not follow them
- Speaking of disruptive technologies…
Are tech stocks too expensive?
It’s a fair question. And one I’ve been asked more than once over the past few weeks.
By and large tech stocks are expensive compared to, say, the banks or mining stocks.
But that hasn’t stopped savvy investors from riding them to even higher levels.
From the Australian Financial Review (AFR):
‘Australian investors have ignored fears that some of Australia’s fastest growing tech companies are over-valued, with the lure of huge long term growth potential making the star players flavour of the month, during annual reporting season.
‘Despite trading on eye-watering price earnings multiples, companies including WiseTech Global, Altium and Afterpay enjoyed substantial post-results share-price jumps, after once again affirming in investors’ minds that their long-term strategies were intact.’
The AFR isn’t laying it on thick when they talk about the ‘eye-watering price earnings multiples’, or PE ratios.
The so-called WAAAX stocks — WiseTech, Afterpay, Altium, Appen, and Xero — are all trading at PE multiples that, at current earnings, would see investors wait a century or more to recoup their investment.
Software company WiseTech is the priciest of them all, with a PE ratio of 216.
That means if you buy shares today — and nothing else changed with the company — you wouldn’t earn your money back until the year 2235. Put another way, if you buy today you’re willing to pay $216 for $1 of earnings over the next year.
But here’s the thing.
While the market price of the stock will rise and fall over time, the price you bought at is fixed. Earnings are not. And the idea — nay, the fervent hope — for investors buying stock with a PE of 216 is that earnings skyrocket.
The maths here are simple.
As I said, the share price will fluctuate with time. If earnings go up, the share price likely will too. With that in mind, we’re not concerned about the future PE ratio. Our concern is with the ratio of the fixed price we buy at relative to variable future earnings.
For a company like WiseTech, doubling earnings would still leave this fixed PE ratio at 113 (216 ÷ 2). Even in a world careening towards negative interest rates, no one wants to risk 113 years invested in a stock only to make good on their investment.
Clearly then investors in WiseTech and other seemingly expensive stocks are hoping these companies will far more than double earnings. That hope is pinned on the massive growth potential of technology stocks.
We’ll look at what our own tech investing expert, Sam Volkering has to say about valuing tech stocks after a peak at the markets.
To discover Sam’s top three investment plays now — tech, crypto, and microcap — just click here.
With a few exceptions — we’re looking at you, Great Britain — global markets are roaring back.
Partly on better than expected economic news out of the US. Growth in the US services sectors and surprisingly strong hiring data from the private sector appear to have eased fears the world’s largest economy is facing an imminent recession.
But the main driver — yet again — is the US–China trade war. Last week the threat level was approaching DEFCON 1. But with high-level talks now set to resume in Washington in early October, that’s been dialled back to DEFCON 3…or so.
And investors took note.
Overnight, the Dow Jones Industrial Average closed up 372.68 points, or 1.41%.
The S&P 500 closed up 38.22 points, or 1.30%.
In Europe the Euro Stoxx 50 index finished up 33.87 points, or 0.98%. Meanwhile, the Brexit battered FTSE 100 lost 0.55% and Germany’s DAX closed up 114.18 points, or 0.96%.
In Asian markets Japan’s Nikkei 225 is up 131.32 points, or 0.62%. China’s CSI 300 is up 0.25%.
In Australia, the S&P/ASX 200 is up 33.64 points, or 0.51%.
West Texas Intermediate crude oil is US$56.25 per barrel. Brent crude is US$60.80 per barrel.
Gold fell 1.2% overnight. Investors piled back into stocks and out of the go to haven asset on renewed hopes for trade negotiations. Those hopes may prove highly premature. And investors shouldn’t forget other forces are likely to push gold prices far higher over the coming months.
The yellow metal is trading for US$1,519.44 (AU$2,277.46) per troy ounce. Silver is US$19.52 (AU$28.71) per troy ounce.
One bitcoin is worth US$10,601.42.
The Aussie dollar is worth 68.14 US cents.
The stocks that set trends…not follow them
Now let’s get back to how you go about valuing seemingly expensive tech stocks.
As a means of comparison, Investopedia tells us the PE ratio of the S&P 500 has ranged from as low as six back in 1949 to as high a 120 in 2009. The current average market PE ratio is around 22.
That’s a heck of a lot lower than even the well established US$910 billion Amazon.com, which currently trades on a PE of 76.
Amazon’s stock holders obviously believe the company has a lot more growth potential ahead of it. And they may be right.
But as Sam explained in Wednesday’s Revolutionary Tech Investor update, nailing the future value of tech stocks is like sticking a moist finger in the air to predict next week’s weather.
‘Tech is more than just gadgets and websites, nowadays. We’re in the midst of developing self-driving cars, robotics, AI, cryptocurrency and much, much more. These are world changing technologies, more impactful than the likes of Google or Facebook. Indeed, that’s why Google and Facebook are investing in these technologies themselves.
‘Trying to put a valuation on something like super intelligent AI is almost impossible…
‘Because the influence of the above examples are unknown, nobody will know how to value them. Which is exactly why we’ll see the seemingly distorted figures more often.
‘It wasn’t that long ago when Amazon had a P/E ratio in excess of 200 times. Even now, it’s still over 70 times. Netflix currently carries a P/E ratio over 115 times. And the likes of Slack, Snap and Uber, all worth tens of billions of dollars — are yet to turn even a miniscule profit, so their valuations are literally whatever the market feels happy with…
‘[T]he markets are always on the lookout for stocks that get ahead of the modern technology revolution. Amazon traded so high because you could see a pathway to profit. You could very clearly see the market they were aiming at, the trend they weren’t following…instead, setting…
‘But with these giants of industry already moving into mega-cap status, the savvy investor now looks to find what’s next…
‘We know that new companies always come to market during periods of technological revolution. You can’t always see their true potential at first. But when you couple them with long term mega-trends, things start to clear up.’
Amazon stock, by the way, is up 81.6% over the past two years. And 436.4% in five years.
Now Amazon and its fellow big tech players could continue to deliver decent gains over the next few years. But with Amazon fast approaching a US$1 trillion market cap, it’s hard to see the share price doubling again anytime soon. Let alone dishing out the 1,000% plus types of gains today’s upstart tech stocks could hand you…if their tech is successful.
That’s why Sam notes shrewd investors need to to find what’s next. And Sam’s preferred — and proven — method for doing this is to first identify the next big megatrends. Only then do you dig into the companies competing to bring those to market.
You can join Sam in tracking down the next big disruptors over at Revolutionary Tech Investor. But as I told you earlier this week, don’t wait too long.
Next week, on Tuesday 10 September, the subscription price goes up by 58%. And it won’t be coming back down.
Speaking of disruptive technologies…
Australia’s Big Four banks have had a lengthy and good run. Even today they’re still among the most profitable banks in the world.
But that’s largely thanks to their oligopolistic position. Not their superior service or business models.
We know all about their service records now. None withstood the harsh light of Hayne’s Royal Commission.
And with technology leaping forward, their clunky business models are also coming under fire. They’re fast losing market share to smaller, nimbler tech savvy businesses.
It’s a trend my colleague Ryan Dinse has been following closely. He calls it ‘the great bank unbundling’. And he’s just released a new report — or four, to be precise — detailing the ‘Big Four disruptors’.
What are these?
Four small-cap stocks Ryan believes are best placed to steal a huge slice of the big banks business. You may not have heard of any of these stocks yet. But if he’s right, they could soon be household names.
That’s all for today. Enjoy your weekend.