Tuesday, June 13, 2017

the only game in town?

The easiest way to understand why you don’t want to make money from the late stages of an expensive/futuristic stock boom is to look at what were considered the lowest-risk ways to play the 1990s boom. Microsoft (NASDAQ:MSFT), Intel (NASDAQ:INTC) and Cisco (NASDAQ:CSCO) were considered “pickaxe” companies to that boom because they were not dotcom flashes in the pan and were drafting on all the activity requiring their software, chips and routers created by the “internet revolution.”

Microsoft’s high stock price in 2000 was $58.38. It bottomed at $17.10 in early 2009. Today, Microsoft is projected to earn $3.02 in 2017 (Value Line). This means the stock sold in 2000 at 19 times 2017 earnings per share. Is it any wonder that investors have only seen 20% appreciation from the height of the Tech Bubble?

Intel and Cisco are even worse. Intel peaked at $66.75 in 2000, and it is projected to earn $2.80 in 2017 (Value Line), which means it traded at 23.8 times 2017 earnings back then. Cisco traded at $77.31 per share at its 2000 peak and bottomed two years later at $10.49. It was projected to earn $2.40 per share (Value Line). It traded for 32 times what it would earn 17 years later. This only happens when you are “the only game in town!”

Are we doing something very similar today? Here are the P/E ratios of the FANG stocks, Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Netflix (NASDAQ:NFLX) and Alphabet (NASDAQ:GOOGL), based on Value Line estimates:
  • Facebook – $4.75 in 2017, P/E ratio 32.
  • Amazon – $7.95 in 2017, P/E ratio 125.
  • Netflix – $1.10 in 2017, P/E ratio 148.
  • Alphabet – $35.00 in 2017, P/E ratio 29.
A quick glance at these numbers shows that Amazon and Netflix are certainly as expensive as Cisco and other glamour large cap stocks were in 1999. Facebook and Alphabet are less expensive – or like what Microsoft, IBM and Hewlett Packard were in 1999. Therefore, as we consider how this might play out, we will ask how the FANG stocks became “the only game in town.” FANG dominance is best represented by their gains since the beginning of 2015 as compared to the gains in the remaining stocks in the Standard & Poor's 500 Index. The chart below shows that the FANG stocks gained 48.92% while the remaining stocks gained 4.96% on an equally weighted basis (1):

...

We have no idea when this euphoria episode will end. However, we believe we know what to do with it. When a group of stocks gets mega-popular, we must avoid the area the same way we would avoid Palm Beach during a Miami hurricane alert. This is especially true when it is “the only game in town.”

-- Smead Capital Management

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[P.S. I personally own every stock mentioned above -- in varying degrees, with no immediate plans to sell.]

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