Will stratospheric valuations come back to earth?
Most large tech companies are valued at significantly higher P / Es than the market average. P / E’s are constantly changing, but right now Apple is at 28, Amazon at 58, and Microsoft at 46, which is insignificant compared to Tesla’s 1,000 times or Zoom’s 154 times – which is clearly absurd.
No company can keep current profits for 1,000 years at the same level.
To put this in perspective, Anglo American and Anglo American Platinum (Amplats) are now trading at P / Es of around 15. Both have doubled their share prices in recent years. Sibanye-Stillwater has tripled, but is trading at a P / E of just six. In a sense, companies with high valuations
are not that strange. The gold and diamond rushes are well known and have led commodities companies to periodically report P / Es of 1,000 or even more, coinciding with high dividend payouts, reflected in percentages. However, most withdrew after the initial rush and excitement, and the real value was exhausted.
Yet Big Tech remains on a roll. It has even spread to more traditional businesses. Warren Buffett’s Berkshire Hathaway is trading 29 times above average. Stocks on the JSE were no exception. For example, Clicks is at 32 and Capitec at 40. Transactional Capital has multiplied by 72, despite the activities of companies in historically risky economic sectors.
High valuations can be a problem, as they distort the markets. A rational investor will think twice before investing in a company that is consistently trading above its average.
For example, at a P / E of 20, some analysts viewed Capitec as overvalued and sold the stock. Now it’s at 40 and climbing, resulting in an opportunity cost and the reality that the stock can only be redeemed at a much higher price.
High valuations also lead to an increase in short-term and long-term trading practices. At high valuation levels, traders often sell the company short, betting that the price will drop. There are massive bets currently on the downfall of Tesla. But that did not happen as Elon Musk’s businesses continue to be viewed favorably.
In some ways, it would have been more beneficial to buy Big Tech stocks betting on higher levels. But that wouldn’t be a prudent, theory-based investment strategy. The belief that central banks will not abandon accommodative monetary policies anytime soon has also been behind the high valuations. Recently, markets have been plagued by inflationary fears in the United States, which could cause the Fed to curb its stimulus bond purchases.
This trend can easily be followed on a daily basis. As soon as there is any indication that central banks may consider raising rates, markets pull back. But when there are assurances to the contrary, the markets are still climbing. Economic policies also play a role. Non-farm payroll data in the United States, reflecting job creation, disappointed in April and May. Markets have reacted favorably as unfavorable news makes it less likely that the Fed will consider raising rates. In contrast, positive economic news led to market setbacks.
There is another problem. High valuations tend to exacerbate inequalities in society. It may sound like a paradox, but it is real because wealth is not distributed evenly across the population. At above-average valuations, only the rich can truly afford to buy at higher levels, and thus increase their personal wealth even further. Recently, Amazon CEO Jeff Bezos bought a chic new yacht worth $ 500 million. In fact, globally, the luxury yacht building industry is experiencing a boom.
How it will all end is a puzzle. Some analysts have said Big Tech is not overvalued from the past and forward P / Es (based on estimated future earnings) have contracted. And high valuations are supported by healthy cash levels. It is all true. But circumstances can change quickly. The markets remain unchanged, so far. The yield on 10-year US bonds was stable at 1.6% in May. The Dow Jones and S&P 500 are up double digit in 2021. One reality has not changed. Wealth can only be created from the level of investment you originally paid for.