I wrote this piece not a long time ago, I thought I would share as there is a lot of overlap with Saul’s method and with recent discussions on this board.
It’s my analysis of an old article that was published just before the dot com bubble started bursting:
Do You Believe? How Yahoo! Became A Blue Chip A tale of how Wall Street and the rest of us learned to stop worrying and love an insanely valued Internet stock.
(note the ironically fitting reference to Dr. Strangelove just months before the meltdown)
It’s a great read all around but here are some notable excerpts:
Today Lise Buyer covers 13 Internet companies. She has a “buy” rating on 11 of them. Yet she concedes, “I still can’t make the math correlate with the stock prices.” No matter.
This is a story about one of the companies Lise Buyer has a “buy” on: Yahoo. More precisely, it’s a story about Yahoo’s stock price, which, as FORTUNE goes to press in mid-May, stands at $158 per share.
Under the old, pre-Internet rules, a company with Yahoo’s revenues and projected growth rate might be able to justify a market cap of, oh, $3 billion. Instead, Yahoo’s market cap stands at $34 billion. Its P/E ratio in mid-May was around 1,062.
Needless to say, after the bubble burst YHOO stock never again rose to even half that price. The lesson here - a company trading at 300 times the revenues (not earnings, revenues!) is insane. Lesson 2, we are nowhere near those valuations now. For comparison - AMZN trades at 4 times revenue, TSLA at 7, SHOP at 20. That’s about as crazy as it gets nowadays.
Despite its unfathomable market cap, Yahoo is now viewed as a stock “safe” enough to be held by mutual funds that manage retirement money for tens of millions of Americans. Analysts routinely categorize it, along with AOL, Amazon.com, and eBay, as an Internet “blue chip.” Fund managers buy Yahoo for “defensive” purposes.
“Do you know why people like me own this stock?” asks Roger McNamee. “We own it because we have no choice.”
McNamee is one of the best-known tech investors in America. He was in on Yahoo’s IPO and has owned shares of the company for most of its brief life. He appreciates the “brilliance,” as he calls it, of Yahoo’s business model and the abilities of Yahoo’s management. He likes Tim Koogle a lot. None of that entirely explains why he’s of late been loading up on Yahoo and other Internet stocks: “I buy these stocks because I live in a competitive universe, and I can’t beat my benchmarks without them.” What he thinks about their valuations is irrelevant. “You either participate in this mania, or you go out of business,” he says. “It’s a matter of self-preservation.”
This was the most striking information for me - institutional investors felt they had no choice but to invest. Just like banks in 2006 felt they had no choice but to hand out mortgages to “no income no assets” folks. I guess when you see this kind of thing happening again, run for the hills!
Having never completely gotten rid of her “valuation bias,” she [Lisa Buyer, the analyst] actually wrote a quarterly “valuation report” for her clients. It was primarily an effort to find meaning in relative valuation measures. But she conceded up front that she was still groping for answers. “People expect Internet analysts to have the answer,” she says. “But we don’t. This is about adjusting on the fly.” In one recent report, she joked, “We think the variable that might most explain current relative valuations could well be the number of weekly mentions on CNBC.” In that same report, though, she wrote bluntly, “At some level, the attempt to rationally explain the valuations on Internet securities is an exercise in futility.”
Another good lesson - if you don’t have a rational understanding of something, better stay away from it.
Now is the time to climb aboard. To look at the list of Yahoo shareholders is to realize that pretty much all of Wall Street is along for the ride. Data compiled by Thompson Financial Securities Data show that Fidelity, AIM, Janus, and Alliance Capital are shareholders. So are Mellon Bank, Chase Manhattan, and State Street Bank. Well-known hedge funds like Tudor Investment Management own the stock. The Ford Foundation owns the stock. The IBM Retirement Plan owns the stock.
Are there any holdouts left? Well, there’s one at least. The fund managers at T. Rowe Price have yet to buy their first share of Yahoo.
Final lesson. Use your head. Don’t invest in ventures you don’t understand and whose miraculous rise you can’t explain just because other people, even famous ones, are investing in them. T. Rowe Price never invested in Yahoo and didn’t lose a cent when the dot com bubble burst.