I find myself constantly amazed at the level to which people will try to assign meaning to movements in "the market." Daily, some parking-lot-scholar-cum-talking-head tells us that "the market is saying this," or "the market doesn't like that," as if there is a hotline from Mr. Market's mouth to her ears.
Pah. It's infuriating to watch investors who, prior to 2000, thought that stocks only go up being told that this "illogical" negativity must work its way through the system so we can all go back to making big bucks in Monte Nasdaq. Guess what, y'all. The logic of the 80% rise in 1999 was just as tenuous as the logic of the big fall is now.
It's time for a reality check, folks. The stock market could rocket up to greater heights once again, but it's a fools' game if that's what you're counting on. The market is a big, dumb brute, which I am more and more convinced comprises the most irrational of all of us.
Did you ever hear that jibe about stockbrokers knowing "the price of everything, but the value of nothing"? That's the feeling I get when I see the majority of what passes for financial commentary. There is one, and only one natural law about stocks: in the long term they will track the performance of their underlying companies' businesses. I am increasingly convinced that stock prices themselves are being treated by speculators as nothing more than commodities, with the wiggles and waggles being more and more tenuously connected to the businesses that they are supposed to track.
In the last three weeks, companies that have had negligible news have moved up by 50, 60 and 70%. Stocks as divergent as Teligent (Nasdaq: TGNT), Broadcom (Nasdaq: BRCM), and MarchFirst (Nasdaq: MRCH) have suddenly pared significant portions of last year's losses, on news that is mostly not meaningful. I was horrified last week when PSINet (Nasdaq: PSIX) rose more than 300% in the days after I came out and said, "Gee, I still think this is a pretty good company."
That's not logical. Companies just should not move 50% plus on news of marginal importance. And, hoping and praying that the Nasdaq will rocket back into the stratosphere is just as illogical. To understand why, let's break out the companies in the Nasdaq 100. This, as most of you know, is a weighted average of 100 of the largest companies on the Nasdaq Index. It's a little different from the oft-quoted Nasdaq Composite, which contains all 4,800 Nasdaq-listed companies. The Nasdaq 100 is the basis for the Nasdaq 100 Trust (AMEX: QQQ) and is a useful proxy for the technology portion of the public marketplace.
The Nasdaq Composite today sits at about 2800, well below its all-time high of 5132 last March. There is nothing out there that says the 5000+ level, or the 4000+ level is "natural" for the index. In fact, 5000, 4000, 3000, and even 2000 are nothing more than psychological markers, completely baseless to the multitude of underlying companies.
Any company will be fairly valued if its price is equal to all future cash flows discounted at an appropriate rate. Now, if there were a fixed methodology to calculate this, there would be no real market, as everyone would be essentially singing off the same page. In fact, since we are in a dynamic system, not only will present and past events effect future values, so will future events -- ones we cannot predict in scope, timing, or effect. The best we can hope for is to be roughly right rather than precisely wrong.
One of the gauges of the appropriateness of a company's price is its price-to-earnings ratio. I use these only as rough guides, because "earnings" are one of the most inherently manipulable numbers. But earnings, and thus P/Es, are useful proxies when one is making a broad-brush assessment, so that's what we'll use here.
Of the 100 companies in the Nasdaq 100, only 72 are currently profitable. Even though the Nasdaq is some 45% below its high, the weighted average P/E of these companies is still 102. This means for every dollar of earnings in the last year, investors are paying $102. That is ferociously high. Some of these companies, among them Vitesse Semiconductor (Nasdaq: VTSS), Network Appliance (Nasdaq: NTAP), Ciena (Nasdaq: CIEN), eBay (Nasdaq: EBAY), and Juniper Networks (Nasdaq: JNPR) have P/Es that exceed 250. Yahoo! (Nasdaq: YHOO), down 85% from its high, is still valued at 72 times earnings. By the way, if you remove some of the non-tech companies from the Nasdaq 100, such as Costco Wholesale (Nasdaq: COST), the weighted average P/E jumps up to 119.
These values are historically, grotesquely high. They mean that today's investor believes that the baseline performance for these companies will be profitably growing cash flows at 50% plus per year for the next decade, only to meet the current price. There is no room for error in these numbers. If you are investing in these companies, are you truly expecting, oh, 15% annual growth in your investment, or are you just hoping that there is an idiot who will buy it for more than you did?
With the U.S. economy in decline, what reasonable scenario is there for a pronounced rebound in the stock market? There really is none, except for the hope that people just plain get excited about some company or another. It's kind of like the Piecyk plan, named for the long-lamented former Lehman Brothers analyst Walter Piecyk, who tried to throw gasoline on the Qualcomm (Nasdaq: QCOM) frenzy in December 1999 by putting a $1,000-per-share price target on the company.
There are huge problems out there. Some of the biggest technology companies have been quite loose with the financing terms they have given their customers, and now that the customers are struggling, those receivables (and future orders) are deeply at risk. Big companies, like Dell Computer (Nasdaq: DELL) and Microsoft (Nasdaq: MSFT), that issued millions of dollars of put options when their stocks were high to gain a little extra cash flow are now staring at potential payouts in excess of $1 billion. And, we're just at the beginning of an earnings season that has already seen a significant number of warnings for the upcoming year.
All of this conspires to point to the obvious: companies that are depending on a rapidly expanding economy and increased capital expenditures have a rough road ahead. Those that made some poor decisions during the recent share-price inflation have some bills to pay. And, investors hoping that their former market darlings will shrug off the effects of both and shoot back up to the moon are delusional.
There are some excellent companies to invest in out there, but we shouldn't be counting on earnings multiples to expand to achieve outsized returns.
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