118% in a Day…
Wednesday, 6 May 2020
By Greg Canavan
In Monday’s Insider I mentioned how Chinese internet giant Tencent Holdings revealed that it had taken a 5% stake in buy now, pay later facilitator Afterpay Ltd [ASX:APT].
Well, hot on the heels of that deal, yesterday quantum computing minnow Archer Materials Ltd [ASX:AXE] announced a deal with US giant IBM to ‘work together on the advancement of quantum computing’.
The stock price rocketed on the news. It just goes to show, there is still the potential for big gains in this market, especially in the tech space.
Of course, if you’re a subscriber to Ryan Dinse’s Exponential Stock Investor, Archer’s exciting story and ongoing potential isn’t new to you. He tipped the stock to his readers back in January.
If you bought in back then, though, you had to endure some pain first. But if you have a look at the chart below, you’ll note (via the red and blue moving averages) that the correction in February and March did not damage the overall upward trend.
This put Archer in a very small minority of stocks, as the COVID-19 panic turned uptrends into downtrends across nearly every sector.
And then, with yesterday’s announcement about the IBM collaboration, shareholders enjoyed a slingshot ride.
Given the announcement is a pretty big deal for Archer, I asked Ryan to give you a bit of a run down on the company and quantum computing.
Over to you, Ryan…
‘We picked Archer on the back of a thesis that endless streams of data will run the world of tomorrow.
‘To make sense of a world awash with data, you need ultra powerful microchips.
‘But the fact is we’re reaching the limit of the current chip tech, that started way back in the early 1970s at Intel.
‘We’re reaching the limits of Moore’s law, the idea that computing power doubles every couple of years as more and more transistors can be squeezed onto a microchip.
‘That simple observation from Intel founder Gordon Moore five decades ago, lies behind the many advances in personal electronics — things such as PC’s, iPads, and smartphones — as well as most tech breakthroughs that are now an ordinary part of your digital-led life.
‘But like I said, this tech is now maxed out. That’s where Archer Materials comes in…
‘You see, the future lies in quantum computing.
‘This is a new field of research that is based on the crazy realities of quantum physics, and I won’t go into that here.
‘But what I will say is that quantum computers are so powerful, they can do in seconds what can take today’s computers thousands of years to do!
‘We estimated in our original report in January that over time quantum computing will turn the half a trillion per year microchip market on it’s head.
‘But to become a reality, this emerging field needs an entirely new type of microchip — a Qubit.
‘Designing a qubit that is stable at room temperature is no easy feat and requires special materials and huge quantum expertise.
‘Archer has both…
‘And that’s why yesterday’s announcement was so exciting for us and our subscribers at Exponential Stock Investor. You see, Archer announced a tie up with IBM to become part of their exclusive invite only, quantum research network — the IBM Q Network.
‘This is not only a great show of faith in Archer’s chip technology from one of the global leaders in the computing world, but will also give Archer access to the leading minds in the emerging quantum computing space.
‘Of course, it’s still early days, but the share rose over 118% yesterday, putting our subs into a tidy profit in just four months, with the hope that this is just the start of a much bigger run.
To finish off today, I wanted to follow up on Monday’s note about Warren Buffett, and the fact that he wasn’t yet buying this market in a major way.
Warren had a cash hoard of around US$130 billion as at 31 March. You’d think he’d be getting a little nervous sitting on such a low returning asset. After all, it represents a large chunk of Berkshire’s equity value of $375 billion (again, as at 31 March).
But no, Warren says prices aren’t low enough yet.
If not now, then when?
To give us a clue, let’s have a look at Berkshire in a bit more detail. If we can come up with an estimate of fair value, it will give us an idea of where Warren sees value.
To get this estimate, you need a few things.
Firstly, you need Berkshire’s return on equity (ROE).
Based on FY21 consensus forecasts, Berkshire will generate a ROE of 6.2%. That’s low. But when a large part of your equity value is cash, it will drag down your overall return.
Given this rate of profitability, what’s a fair price for Berkshire?
Ahhh…the answer to that depends on the discount rate used.
This is one of the most important numbers in finance. It is the rate used to ‘discount’ future expected cash flows back to a present day value. Put another way, it’s the return you want to achieve from an investment, given an expected level of earnings or profitability.
From my past study of Buffett, I know that he uses a relatively low discount rate. That’s because he invests in large businesses with relatively secure, stable earnings.
So let’s assume a discount rate of 6%.
Given the ROE is around 6%, this means fair value would also be around the ‘book’, or equity value of the company.
Berkshire’s current market value is around US$445 billion, compared to its book, or equity value, of US$375 billion. So it’s trading at a 20% premium right now. But that equity value moves around as the price of Buffett’s publicly listed companies rise and fall. So it’s not necessarily a fair reflection of Berkshire’s true equity value.
Still, the fact that Buffett wasn’t buying when Berkshire’s stock was considerably lower in March, suggests he could be using a higher discount rate.
Using a 7% discount rate then, gives me an estimate of fair value that is at least a 20% discount to Berkshire’s book (equity) value.
Clearly the share price is no where near that level.
That Buffett’s not buying now suggests one of two things:
- Stock prices are too high and offer a poor risk/reward
- Buffett is being overly conservative and using too high a discount rate to value stocks
I do concede that this is a pretty crude approach. Berkshire’s book value is clearly not an accurate representation of the value of its assets, given a chunk of it moves with the vagaries of the market.
But still, the lack of buying tells you something, no?
What do you think?
Send me an email at firstname.lastname@example.org and let me know.
Or, if the intricacies of valuation isn’t your thing, feel free to write to me about anything else that may be of concern or interest. I’ll answer any questions you may have in Monday’s Insider.