The valuation of current tech companies is way astronomical compared to what is considered normal for mature companies.
The average price to sales for S&P used to be between 1.5-2.5 for many decades. However for these newly IPO companies the price to sales ratios are around 10-15.
Similarly the P/E ratio for S&P companies used to be in the 15-25 range to the considered normal .
However with these internet companies, they usually do not turn a profit or if they do, their PE ratios usually lingers in from ~100 to 1000. And the market considers that normal behavior now.
Well, to some extent it is. You can argue both ways, and in Zapier's case, I'd say it's overvalued as the 10-15 range assumes obtaining a monopoly. I don't see how Zapier will do that since there's also IFTTT and other services I've tried.
With that said, consider huge successes like Amazon. Huge successes like Amazon have been generating much more profit compared to what they were projected to earn in 2010 [1]. I picked 2010 since 2 things are out of the way: the tech boom and the credit crunch. Moreover, people understood that Amazon was here to stay. Despite that, 10 years later, they make 20 times as much profit. If investors knew that 10 years ago, I'd bet that the price would not have been about 130$ since according to Google Finance, the diluted earnings per share (EPS) is about 42$, which is about 30% of the 2010 stock price.
Mind you, in 2010, investors already put crazy multiples on stocks like Amazon. Yet, their prediction on how much money it would make has been underestimated back then. If the estimates of 2010 were correct, you'd expect Amazon to now have an EPS of like 6.5$ (130/20) since by conservative measures, the P/E ratio is in the 15-25 range.
Correct me if I'm wrong on this, I'm not the sharpest cookie in the jar.
However, Amazon never pays dividends. And you probably cannot really vote on anything with your stock either. So what's the point? There is an interesting article about Facebook with a similar opinion. Zuck owns the majority vote and they never pay dividends. What's the point of owning the stock?
to sell for capital gains when it is higher in the future. Dividends aren't the only way to generate a profit. And for a lot of high income earners, dividends are very tax inefficient as well.
Yep but when our 401ks auto buy in there's a bit of a stop gap. Also I think the bigger reason is that with tech people expect a nonlinear impact. Amazon being the example. So not only revenue break even but market growth and new market opportunities.
Dividends are taxable while price appreciation doesn’t become taxable until you sell. Unless you need income, it’s more tax efficient to shareholders if the company reinvests free cashflow in continued growth.
> However with these internet companies, they usually do not turn a profit or if they do, their PE ratios usually lingers in from ~100 to 1000. And the market considers that normal behavior now.
That's not normal, it's pure stupid. So if you don't think there are people sitting on the sidelines watching idiots bid up shares way, way beyond the replacement value of companies, you're not watching the same thing happen that others are.
Do people even understand what these numbers mean? It means after expenses, assuming no future growth, that's how many years it would take to make back your investment.
Do you know why a P/E ratio of 15 was historically considered high? Because even with modest growth, no one wants to wait 15 years for corporate revenues and acquisition costs to break even. News flash, 15 to 25 years isn't normal.
The average company doesn't even make it 15 to 25 years these days.
This argument is based on the idea that stock markets should price rationally based on value, but evidently that's not really how the markets work. Share prices have -- and need -- very little connection to any "true" value of the business whose stocks are being traded. For the basic investment strategy of trying to buy low and sell high, investors win if the stock subsequently goes up and lose if it subsequently goes down. The reason for the change, if there is any logical reason at all, is largely irrelevant.
Assuming any sort of pricing rationality risks the well-known problem that the markets can remain irrational longer than you can remain solvent. It should never have been possible in a rational market for the recent WSB pump-and-dumps to work, yet many billions changed hands as a result. Not that I have much sympathy for the losers on that one, because it should also never have been possible in a rational market for the short-selling strategy that left them vulnerable to work either. Both groups got away with something dodgy for a while and then some of them lost a lot of money when the house of cards fell.
Whether this disconnection of prices from real value is a healthy way for stock markets to operate as a key element in our financial systems is a separate question, and it's one that a different and probably much smaller group of people care about.
As a footnote, it's probably worth mentioning that some businesses, including tech stocks, don't necessarily follow the traditional models for either growth or dividend payments. So although those P/E ratios might be considered very high by traditional standards, those traditional rules of thumb aren't necessarily useful in these cases, even if we only look realistically at the potential for future profits. A high-growth tech startup might have low earnings in the early days and rely on some big investments for funding instead if it's building a huge user base without yet having a firm strategy for monetization, for example. That doesn't mean it won't have genuine potential to earn a huge amount of money from that huge user base later on if it does find the right monetization strategy.
I think it is fair to say 15-25 is pretty normal. The average P/E on the NYSE has been above 15 for the last 30 years, and most of it's 90 year history.
An easy reality check is other asset classes like bonds or real estate. If you are doubling your money after inflation in less than 15 years you are either gambling or outsmarting the the market.
The problem is that there's too much money lying around and nowhere to spend. Look at Softbank: throwing money at some most absurd companies with the hopes someone else will pick up dogs shit when they're gone. VCs are flushed with money and that's how the model works. At least for now.
> The average price to sales for S&P used to be between 1.5-2.5 for many decades. However for these newly IPO companies the price to sales ratios are around 10-15.
You’re off by anywhere from 2-20x on the price to sales multipliers. At one point Snowflake had a market cap of nearly 200x the projected sales of the next twelve months. Before rates started creeping up, most SaaS was trading between 20-40x NTM and up to 60-80x on upside spikes.
So the theoretical reason for the high values of tech companies is that margin is one of the biggest drivers of value in a dcf, due mostly to the non linear nature of division. However, many of the tech companies we’re seeing don’t have near those margins, they are in fact negative.
