Update: the fragility of our overvalued stocks

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Update: the fragility of our overvalued stocks

A few days ago, in response to those who continue to see our SaaS companies as way overvalued, and sure to decline more than the market on any market setback, I wrote:

Yes, I think they probably would go down further than the S&P in a real crash, but that’s not a sure thing, as each time the S&P has fallen in the past couple of years these SaaS stocks have sometimes done better and sometimes worse, but not consistently worse.

I gave an example three days ago when the Dow was down 0.46, the Nasdaq was down 0.62, the S&P was down 0.48, the Russell was down 0.94, and the IJS was down 1.09, for total uniformity.

Here’s an update, some days later:

As of today, since the end of August, the Nasdaq is down 2.56%, the Russell is down 1.61%, the IJS is down 1.56%, the S&P is down 1.03%, and the Dow is down 0.19%. Those are some serious negative numbers. I think I read that the S&P and Nasdaq were down all four days this week. That’s a real headwind for our overvalued fragile stocks. No wonder that my portfolio only rose from up 86.0% to up 91.4%.

So, no, it’s not a sure thing that they will do worse than the averages in a decline. Still very possible, I’d even grant you “probable,” but not a sure thing at all.

And again, stock picking doesn’t work! You can’t beat the market. All those studies have proved it! Even very convincing books have been written to prove it. Oh yes.

Best to you all,

Saul

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These small, run-of-the-mill declines don’t really reflect what happens when risk appetite REALLY shifts.
When “return on capital” stops mattering in the mind of investors and all that matters is “return of capital”.
The same bad news item that in the current climate will cost a stock 3% will then cut its price by 30% (and that’s after the price has already declined by 50%+ over the course of a year).

For those who haven’t experienced 2008/2009 (or 2000-2003, for that matter), they cannot imagine what that is like.

For those who are sitting on these speculative tech stocks, please understand that many of them will go down 75+% between now and the next recession.

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For those who are sitting on these speculative tech stocks, please understand that many of them will go down 75+% between now and the next recession.

Thanks Devil’s Advocate. It’s always good to get an opposing point of view, although it would have perhaps been more effective if you knew something about the companies and realized that there is nothing speculative about companies growing sales at 50% or more year after year, and whose revenue is almost all recurring, and who have loads of deferred revenue that is already in the bank. Overvalued, I could discuss with you, but calling them speculative just gives away that you don’t know much, if anything, about them. :grinning:

Best,

Saul

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For those who are sitting on these speculative tech stocks, please understand that many of them will go down 75+% between now and the next recession.

Well…you could get run over by a bus by then, so wouldn’t make much difference.

A diabolical advocation!!!

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For those who are sitting on these speculative tech stocks, please understand that many of them will go down 75+% between now and the next recession.

I agree that there have been major hits to tech stocks specifically in the Y2K debacle.

The problem with your statement is that this has been said for the past several years…here’s just one example 3 years ago:

http://time.com/3741681/2000-dotcom-stock-bust/

Essentially, Cuban thinks that despite the huge investments many start-ups are getting, there just isn’t any real cash in those companies. Eventually, that will become apparent, but the investors will be stuck.

That advice was 3 years ago…had you followed it…perhaps you did…you really missed some massive gains.

But recognizing that a broken clock tells the right time twice a day, I do think there is some validity to your caution…Not long ago, I posted pretty extensive data on when that time is upon us. But for sure until then, there will be pullbacks, September is historically a bad month for stocks, etc.

But 75% drops…that would require more to have occurred than the usual fits and starts of the market in general.

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I could be wrong, but I see many of these identified as companies that help other companies maximize profits through understanding and improving business operations.

Utilizing OpEx, these companies are reducing spend to better allocate and operate the business with precision versus blunt bets.

Further, as a solution is outsourced, depended upon, and further subscribed to, internal client resources shift their skills to managing the vendor versus doing the work, further widening the moat.

The companies invested here all center around a wave that is hard to see being severely impacted by a huge recession, shifting from on-prem storage to cloud solutions. When you are talking about the cost, mobility, and production gains from these types of solutions, it’s hard to imagine economic changes being a sector killer as predicted above.

These aren’t companies changing their names and missions to “block chain” and seeing 1000% gains…these are companies winning multi year subscriptions and then expanding their reliance into businesses.

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but calling them speculative just gives away that you don’t know much, if anything, about them.

So much for the Monday Morning Rules.

Instead of the personal attack, how about asking the poster what they mean by speculative.
That way you encourage meaningful discussion rather than just pushing your point of view.

Ears

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Instead of the personal attack, how about asking the poster what they mean by speculative.
That way you encourage meaningful discussion rather than just pushing your point of view.

Hi ears,
I’ll take JAF’s post as my response:

I see many of these as companies that help other companies maximize profits through understanding and improving business operations. Utilizing OpEx, these companies are reducing spend to better allocate and operate the business with precision versus blunt bets.

Further, as a solution is outsourced, depended upon, and further subscribed to, internal client resources shift their skills to managing the vendor versus doing the work, further widening the moat.

The companies invested here all center around a wave that is hard to see being severely impacted by a huge recession: shifting from on-prem storage to cloud solutions. When you are talking about the cost, mobility, and production gains from these types of solutions, it’s hard to imagine economic changes being a sector killer as predicted above. …these are companies winning multi year subscriptions and then expanding their reliance into businesses.

When someone says companies like this will lose 75% (!) of their value “between now and the next recession”, he really hasn’t bothered to learn anything about the companies being discussed but just wanders in and attempts to drop a disruptive bombshell. He didn’t even know that they were SaaS companies but just referred to them as “speculative tech stocks.” It’s laughable! They will lose 75% of their value between now and the next recession? What a joke. When someone (a troll) drops in and tries to bombshell us, I feel justified in calling him out.

But thanks for your comments

Saul

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I remember when Enron lost more than 99% of its value - it was not speculative, it was a case study at Duke MBA!

I remember when Proctor and Gamble lost 50% of its value in one day. No one can call P&g a speculative stock.

On the other hand I can remember making a triple on Nvidia, and yet despite this, its EPS multiple is still about the same as it was back then. Now is that speculative? And is that more speculative because Nvidia largely has a world wide monopoly with only AMD as its foil?

The term “speculative” has been given the connotation that we use to denigrate a soulless corporation or a racist person, or whateeer general slight is used without any explanation as to why you call it that.

SO yes, Saul is absolutely correct. If you want to call one of the most dynamic new growth business in the world speculative, then you better darn well be able to articulate the specific reasons why it is speculative, other than every investment in the world is speculative.

Tinker

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I offer the thought that risk lies in two speculative possibilities. Some people here do not care what the multiple of sales is. That’s fine as long as they remember the market may take the same view and reduce the PS of a software smallcap in short order from 18 to 8 (or lower) when the overall market collapses. Second, the market under such conditions tends to look less favourably on the characteristics of technology companies with their frequent surprises, sometimes rapid obsolescence and proneness to ambush, preferring porridge and toothpaste and things which don’t go bump in the night.

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Overvalued, I could discuss with you, but calling them speculative just gives away that you don’t know much, if anything, about them.

Valuation plays a great role in how speculative a stock is, don’t you think?
If these companies were one third the price, I’d probably not call them speculative.
And then these are all tech companies, and we’ve seen plenty of examples how fast those business models can become obsolete, no matter how secure they looked just a year or two before.

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Hi Saul,

Thanks for responding. I can see why the word ‘speculative’ set you off. You focus on business
fundamentals. Speculators bet on price swings.

Keep in mind that salesforce.com (CRM) – the poster child for SaaS companies – lost 67% in three
months and 60% in one year in the financial crisis. More recently, Shopify (SHOP) lost 42% in three
months the latter part of 2015/early 2016, and there wasn’t even a recession. So the poster doesn’t
seem to be that far off. Maybe they know SaaS companies better than you think.

The other thing is all the companies in your port have been public five years or less. We haven’t
experienced what will happen to their businesses when demand dries up and capital dries up. So I
can see why an experienced investor – like that poster – might consider these speculative.

But of course it is your board.

Ears

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SO yes, Saul is absolutely correct. If you want to call one of the most dynamic new growth business in the world speculative, then you better darn well be able to articulate the specific reasons why it is speculative, other than every investment in the world is speculative.

As an example, NVDA has a trailing P/E of 40. That’s a speculative stock, because this high level of valuation requires the company to continue growing its profits at a substantial double-digit rate for several years.
Right now, investors think that it will do so. But that is hope, not certainty.
And when the market as a whole goes down prior to the next recession, investors sentiment will change and the hope premium given to stocks, including NVDA, will largely go away or even reverse.
Without anything going wrong for NVDA other than perhaps a recession-related dip in earnings, the stock could very easily fall by 70+%. That kind of thing would be normal for a recession-induced bear market.
I just want to be sure that people are aware of that.

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@Saul
I’d define a stock as “speculative” if a lot of hoped-for future developments are built into the price.
That seems to apply to pretty much all the stocks I see discussed on this board.

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Keep in mind that salesforce.com (CRM) – the poster child for SaaS companies – lost 67% in three
months and 60% in one year in the financial crisis. More recently, Shopify (SHOP) lost 42% in three
months the latter part of 2015/early 2016, and there wasn’t even a recession. So the poster doesn’t
seem to be that far off. Maybe they know SaaS companies better than you think.

Yes, but you miss the forest for the trees. First, if you had held and bought more of Salesforce you would be quite smiling.

In regard to SHOP, It falling back to the $90s for a short period of time, then back to the $160s, and then back down to the high #130s, low $140s, I still have more than a triple at the low, and made some profit on a quick swing trade in the $90s.

Also, I stopped owning SHOP around that time, because at that time the fundamentals for me had changed. We had a lot of big discussions in regard.

So I could have bought REIT, or a reinsurance company (which btw also fall big time on events), and not invested in great world changing growth companies BECAUSE shares can be volatile both up or down, or I can simply decide I do not want to make outsize profits.

The term “speculative”, “risk”, just ask your neighbor who does not manage his own 401K what his or her stock returns are in the account and then compared to our long term returns, through crashes and peaks and valleys and whoas and euphoria hurrahs!

I believe what is irksome is that these people who call it “speculative” place some more value on that term, as if it is immoral or simply LUCK. What they fail to understand is that it is based upon FUNDAMENTALS. SHOP’S fundamentals, Salesforce’s fundamentals were simply SUPERIOR to those “non-speculative” stocks, whomever they may be. Because they all went down as well.

Hey, who here was invested in Lehman Brothers or the like, 100 year Investment Bank on Wall Street, staid, true, solid, CERTAINLY NOT SPECULATIVE BY ANY MEANS…urghhh, they went to 0 and never came back.

So who is more speculative, Goldman Sachs or Salesforce? I can tell you who has had much higher stock returns? Over the last 5 years Salesforce (CRM) has beat Goldman Sachs but 6x in returns. Good old Goldman.

So instead of using the pejorative, “speculative” why don’t you focus on the actual elements of each investment. Labels hide lack of knowledge. Saul is absolutely correct on this. Labels are conclusory statements. What you need to do is articulate the elements that cause you to conclude that something fits a label, and then define what the label actually means so we can actually understand what you are talking about.

Tinker

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As an example, NVDA has a trailing P/E of 40. That’s a speculative stock, because this high level of valuation requires the company to continue growing its profits at a substantial double-digit rate for several years.

So just because of the 40 PE, NVDA is a speculative stock? Then investing is really easy. I can just pick those stocks with a low pe. No need to consider gross margin, growth rate, TAM, CAP, etc.

You sounds like master investor and assume many here are just speculators with little experience. I suggest you take a little more time and really open your mind to read through the posts. Then check your investment records and compare it to the S&P 500 to see if you really outperform in the long term. If not, maybe your investment method also need some improvement. Maybe you could learn something from this board. No need to come to a new board and give lecture right away without really understand it.

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Saul, you keep saying this:

“if you knew something about the companies and realized that there is nothing speculative about companies growing sales at 50% or more year after year, and whose revenue is almost all recurring, and who have loads of deferred revenue that is already in the bank”

First, is it really in the bank? Do they sign a 3 year deal with payment up front but recognize it monthly? In the case of a painful recession, this is very relevant to customers that reorganize or go bankrupt.

Second, you say it’s recurring. But the downside of a SaaS or PaaS offering, which I know of firsthand, is that that the other side of the coin of being able to ramp up quickly and expand quickly is that someone can cut their seats in half or drop you without a thought. For example, MDB is definitely not as sticky as you all think, and I say that as someone that has removed Mongo from an application.

Third and last, the one fundamental rule of valuation that will never change is that a company is worth the discounted sum of future distributable cash flows plus liquidation value. I have defended high P/S and P/E stocks on MF boards on that basis. If a correct bends the growth projects on a high growth stock slightly, the current valuation can suffer a lot.

I guess, as a postscript, one of the most annoying things about momentum investors when they’re winning is that they think it’s all about them. You all are minnows flowing with the current, which is the flow of money from whales like Fidelity, Blackrock, Price, Vanguard et al. Nothing but their opinions of the valuations matter, so it’s probably worth anticipating how they act.

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Advocatus, did define his definition of “speculative” and that is if future growth needs to occur to support the valuation.

I would counter that it was more certain that Shopify was going to experience long-term hyper growth for multiple years, even through a recession coming out of it again, than it is the a “non-speculative” stock is likely to even double in 5 years.

It is all about risk. Risk is uncertainty of an outcome x what you might lose. There is a very large opportunity cost you forego, and there is misunderstanding what is likely to grow or not.

Cloudera, always a slow grower, with concentrated customer base, is one of the rare SaaS type companies, more of a PaaS, that stopped growing. If their growth was and is so speculative, name another PaaS or SaaS that we discuss here that did not grow in hyper growth for many years?

Once you conduct that exercise you will learn that these companies were disrupting what came before them and had so much greenfield that the risk that they would not continue to grow was minuscule. Do the exercise, as the results will speak for themselves with a roar.

I have had discussions about Nvidia on the premium boards. I love to keep in touch with what is going on, but Starrob (don’t get me wrong, I appreciate his contributions very much) was talking about potential disruptions to Nvidia that might happen, 3, 5, 10 years down the road. I said, wait until they actually put out a commercial product, because otherwise you will scare yourself out of a great investment because you misdefined execution and competition risk.

Nvidia’s competition risk was close to zero. They had execution risk. And any future competitor would be blared in the headlines once they actually produced a product so that all could see for themselves if it was material.

Given this, all that can be said is that the risk was utterly misconceived by the RULE OF THUMB and that is what gave opportunity for great returns as every earnings call the RULE OF THUMB folk panicked, and they said the most common phrase in the book, “future upside is priced into the shares.”

The worse investment advice I could give to someone is to actually follow that advice.

Yes, recessions will come, and then we will be tested again, but WHY INVEST LIKE WE ARE IN A RECESSION WHEN WE ARE NOT! That is like pulling out and opening an umbrella on a sunny day on the golf course just in case it might rain later (and we know someday it will rain again), even though there is no sign of rain in the sky.

Now Monday, we may wake up to find China dumping all American debt in order to crash the world economy, and with the increase in interest rate this will cause, triggering a government debt repayment crisis around the world as governments become unable to afford all the deficit spending that they financed when interest rates were low. At that point in time, we are all screwed. Could happen. Likely won’t. So I should probably not hold “speculative” stocks then on that basis.

Tinker

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So just because of the 40 PE, NVDA is a speculative stock? Then investing is really easy. I can just pick those stocks with a low pe. No need to consider gross margin, growth rate, TAM, CAP, etc.

Don’t play daft.

… and assume many here are just speculators with little experience.

Some will be. I’ve seen lots of people with little experience get hurt terribly during the 2000+ and 2008+ bear markets. I want to make sure that they at least get told by someone what can - will - happen to a portfolio of tech stocks in the next bear market.

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Many of these companies are growing sales at 40 to 60%, have no earnings and market has valued them at P/S of 20+, and even 30 for ZS and SQ! If their growth drops to 20-30%, market will react very unkindly. It is not unreasonable to expect a 50% cut in stock price. Also, in a bear market growth stocks with no earnings have generally done poorly as compared to value stocks.

I am slowly dipping my toes into these SAAS stocks but certainly concerned about the valuation. Back in 2000, B2B looked great as this MF article indicates
https://www.fool.com/archive/portfolios/rulebreaker/2000/08/…

ARBA had incredible revenue growth rate 33x in 3 years! But it crashed and lost 90% MCAP.
http://tomtunguz.com/ariba-history/

Another company I had Commerce One in the same B2B marketplace lost 99% and did a reverse stock split!

Even if a company escapes unscathed in a bear market we don’t want it to perform like CISCO which is a fine company but still valued 33% below its 2000 peak! An even finer company like AMZN hit $100 in 2000. Its stock has grown 20x since then but between 2000 and 2010 the stock didn’t go anywhere even though its revenue went up from 3B to 30B. Essentially the P/S of the stock fell from about 17 to 1.7!

Challenge is which of the current SAAS company business models are sustainable over the long term even across bear markets? I have learnt ZS, MDB have no competition. Does that mean that even in a bear market their services are irreplaceable?

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