Valuation Concerns is not a Contrarian Indicator

There seems to be an idea that if people are saying a certain asset class is a bubble, overvalued, etc., you can use that as a “contrarian indicator” to suggest there is plenty of room to go because it means there are still a lot of non-believers that would have to be converted before a market peak would occur. I submit that articles talking about valuation concerns are meaningless as an indicator for when a top will occur.

You can already see what happened over the last year with bitcoin. When it peaked at 20,000 in early 2018, there were plenty of articles talking about a bitcoin bubble. There were plenty of people still going around talking about how it was pure speculation. So how did these articles help there?

You can also find plenty of articles basically stating as fact that internet stocks were overvalued in 1999. Alan Greenspan basically called internet stocks gambling.

There were also articles of the real estate market in the mid 2000’s saying house prices got away from themselves.

So the fact we’re even having this conversation is a danger sign to me. But the real only useful takeaway for me is; the asset class in question does not fit into “fair value” or “undervalued” using conventional investment valuation methods. That’s about it.

So if someone says “Zoom is overvalued”, I don’t think the right way to think about it is “Good, there are still non-believers out there. I am no longer concerned. If everyone thought Zoom were undervalued I’d be worried.” On top of that, going off some article or some comment on Fool Message Boards isn’t exactly something that would be accepted in a peer reviewed journal as a useful scientific study. I still think the right way to approach it is “Do Zoom shares still offer potential for reasonable appreciation if everything goes as planned?” and “How likely is the best case scenario that would have to happen for any share price appreciation?” Zoom and Crowdstrike in particular I believe offer some sort of benchmark for realistic TAM. We can add up the market cap of all big players in their space. Unless Crowdstrike is somehow going to ignite huge market growth in endpoint security. Which is just another thing that you’ll have to bank on for any meaningful share price appreciation. I believe we can even gauge Elastic’s TAM by adding up all the players in the space it competes in. MongoDB, to me, has the biggest gray area for how big TAM really is. We don’t truly know how big non relational document databases will truly be. I just go off the articles that indicate most data out there is non-relational. Meaning MongoDB could actually some day be bigger than Oracle. Which is pie in the sky indeed but it suggests to me MDB could be a lot bigger one day than it’s current $9 bill market cap.

At the end of the day there still has to be some kind of method to rank stocks among one another for appreciation potential. Unless you just completely ignore valuation and are willing to buy Zoom at $30 billion as you are MDB at $9 billion.

11 Likes

Hey 12x. I agree and disagree.

Being considered “overvalued” is not automatically a good thing. Won’t get into Bitcoin other than to say it’s impossible to actually value so it doesn’t matter.

Also sure, bad businesses being considered over valued isn’t good.

But great businesses being considered overvalued can be great.

Even David Gardner thinks so. It’s one of the 6 traits of Rule Breakers he looks for. He shared this publicly on the free podcast so I’ll share here.

Trait 6: Overvalued, According to the Media

2 Likes

But great businesses being considered overvalued can be great.

Even David Gardner thinks so. It’s one of the 6 traits of Rule Breakers he looks for. He shared this publicly on the free podcast so I’ll share here.

Trait 6: Overvalued, According to the Media

OK, so why would it be great? SO if Zoom doubles over the next year, and even more people call it overvalued, that’s a sign to buy? If it’s $150 billion market cap and even more expensive it suddenly becomes more enticing? Also, David Gardner published the Rule Breakers book in 1999 with that rule in it. That’s the exact kind of market where overvalued stuff goes up, so of course it would work then.

I see absolutely no reason for a stock to be considered overvalued by the media to be a good thing. It’s biggest bull market in the history of USA logic. If there’s anything useful out of it, is that it’s favored by the market as a whole due to rising share price, the same picture you can get just by looking at the chart and checking Relative Strength. Which looking at charts/RS does make sense.

I think we’re all on the same page here on what we’re looking at to see if the media calls it overvalued. Not the recent biggest losers on wall St. Not GE. I bring up bitcoin but you exclude it because it’s impossible to value (well, I can make that same argument for about every stock we discuss on here, which is why it’s a subject and not decided by obvious fact), which, I only brought up because it was a recent bull that crashed. Name one strong bull market that peaked and fell that wasn’t being called overvalued. That’s my point. So it’s not helpful.

3 Likes

Looking for people to call things overvalued and using it as a contrarian indicator may serve one purpose; to maintain the mindset that valuation does not matter. If it doesn’t matter it doesn’t matter period. ZM could be at $30 billion, could be at $75 billion. It doesn’t matter and the market has to let it happen anyways for you to be faced with that quandary, which you can simply ignore. You simply buy whatever stocks you want regardless of price. Regardless of any valuation metric whatsoever. It’s something I’ve considered but it still seems to me you would want some sort of ranking between stocks to see which have the biggest price appreciation potential. Which I’ve used market cap/TAM but maybe I should throw that out the window too. Because that’s the only way I can start justifying CRWD or ZM.

3 Likes

12x,

I am getting frustrated about this thread because for the most part we are talking generalities and extreme cases of Zoom or Crowd. Crowd we have discussed the specific case and perhaps its CAP does not justify the valuation. Zoom, we have mostly agreed, with some dissent, that it is a great business, with a difference of opinion on whether or not the remarkable price to sale is warranted.

I am on the side that it is not, given the risk/reward. However, Mobileye did sell to Intel for 32x forward sales, and Mule sold to Salesforce for 16x forward revenue. I don’t recall what a more mature company like {that open source company} sold to IBM for, but it was a rich multiple for its growth.

My frustration is specific, company specific valuations. I have asked, example, for Zscaler. Is Zscaler overvalued so that it is an irrational bubble? If so, why? Mongo, AYX, etc. I would like to talk specifics, not generalities. I have already put my opinion down in regard to specifics.

Thank you.

Tinker

24 Likes

My frustration is specific, company specific valuations. I have asked, example, for Zscaler. Is Zscaler overvalued so that it is an irrational bubble? If so, why? Mongo, AYX, etc. I would like to talk specifics, not generalities. I have already put my opinion down in regard to specifics.

Tinker, I don’t think how I value growth stocks will be rigorous enough for people because it’s not rigorous. What I will tell you that I DON’T do is sit there and extrapolate recent numbers out into the future and put some multiplier on it. It is just useless to do so in my opinion because reality will not work out that way 99.99% of the time. I already mentioned MDB possibly being undervalued, but my logic is as follows: there is a huge amount of data out there growing every day. The vast majority, by some accounts, is that 80% of data is non-structured meaning it would not fit into a relational database. That means the non-relational database market could actually be the biggest market of all. Of course the 80% number could be overblown, and of course businesses may feel it’s not worth messing with the majority of that data, but it suggests to me that MDB could one day be as big as Oracle. MDB trades at a small fraction of Oracle. Thus MDB is a buy. Sound like a ridiculous thought process? Well, I don’t think it’s any more ridiculous than sitting there calculating the next 2 years worth of growth and slapping a multiplier on it.

Alteryx; they get more revenue per customer than many other data analytics businesses in their space, moreso than Tableau for sure. Offhand Splunk is the only one that I know of that gets more per customer. Obviously there are differences in the companies and products but Alteryx just recently expanded their TAM in their most recent quarter. While they say they are going to go after the quality of customer versus quantity, MAY be their way of hiding the fact they can’t find new customers, I’ll follow along and see if their rev/customer goes up. The fact they get so much per customer suggests they could one day be as big as Tableau, which is like a $15 billion company. So there is room for growth.

ZScaler is a tougher one. Since they are doing something unique I don’t know how big that market will be. I look at Palo Alto that is valued at multiples of ZS (especially when I began buying) and being in the same industry, Palo Alto itself at 2x the value of Symantec yet only half the revenues of Symantec, the only difference is one is growing and one is not, so if PANW gets to Symantec’s size probably won’t be growing as fast either but the market places such a premium on growth it doesn’t look to the valuation at terminal growth stage of a company’s life it seems. But ZS could be a $20-30 billion company if it keeps growing.

I understand this is all amateurish but I’ve seen enough growth estimates and have done enough in my early days of investing to know they aren’t worth squat when it comes to predicting what really happens. I don’t do any growth estimates whatsoever, just react to what happens. May as well be calculating GDP growth of USA next year and if there will be a bear market if you are going to do that. The downfall is this method may favor small caps, but I think I have learned my lesson somewhat. I recall when AAPL was brought up like 6 years ago or whatever, already a mega cap, but growing strong, I said the market cap should not dissuade you from buying, as it is in a huge industry and their new AppleTV could be a big growth driver (I was wrong about one thing but right about the other, just the wrong reason).

My next step would be to ignore valuation altogether.

24 Likes

I would also like to add, aside from the fact Alteryx stating their TAM is even larger now (the 3rd party analytics firm, I believe IDC is the one who measures it and whose data they use), their CEO has been pretty spot on as to what is to be expected in the data analytics industry; consolidation. He said he was not going to enter that market until some of the firms got taken out of the picture, which, with Tableau being bought out, seems to be an indication he was right. These are the two things that suggest to me that AYX could continue to see growth in the quarters/years ahead. That, the fact that Excel spreadsheets seem to be their only real competition, I’ll take them at $6 billion.

Everybody out there seems to need to back up their analysis with taking last year’s growth, and multiplying it by x percent, and putting a multiplier on it (I can do that too). But what is the likelihood of it happening like I, or anyone else, calculates? Way too many things can happen over the next year or 2.

5 Likes