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These 5 tech stocks are in a dot-com-like bubble (and they aren’t all FAANGs) - MarketWatch
These 5 tech stocks are in a dot-com-like bubble (and they aren’t all FAANGs)
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Spot the micro bubbles.
Although the overall stock market looks reasonably valued, there are pockets of extraordinary risk where stocks with 2000-bubble-like valuations lurk.
Specifically, there is a “micro bubble” in certain tech stocks, where valuations reflect expectations for future cash flows that would require unrealistically high margins, growth, and market share. These expectations might not be so “bubbly” if not for the fact that the current margins and cash flows of these companies have trended at very low or negative levels for years.
5 tech stocks in a micro bubble
Figure 1 lists the five tech stocks we put in our first micro bubble. They share a few key characteristics:
• Low or negative return on invested capital (ROIC) and free cash flow
• Unrealistically high valuations: all 10 companies either have negative economic book values, or they have a PEBV above 20
• Expectations that they achieve heretofore unseen dominant market shares
These are five of the largest micro-bubble companies. Briefly, here’s what makes each of these companies part of the micro-bubble.
Amazon
Fun fact: Amazon’s AMZN, +0.20% $885 billion market cap is higher than Walmart WMT, +0.45% Home Depot HD, +0.69% Oracle ORCL, -0.39% and Disney DIS, +0.53% combined. Investors are betting that Amazon can grow to dominate multiple industries while earning significantly higher margins than it does now.
Amazon has finally shown an ability to earn a profit, but it still must grow net operating profit after tax (NOPAT) by 30% compounded annually for 19 years to justify its current valuation. See the math behind this dynamic DCF scenario. For comparison, only six companies in the S&P 500 SPX, +0.28% managed to grow NOPAT by 30% compounded annually for just the past 10 years. Maintaining that growth rate for nearly double that time frame would be an extraordinary feat.
Amazon prefers to point investors to free cash flow, but its reported free cash flow numbers are an illusion. In reality, the company continues to experience significant cash outflows.
Investors who focus on understanding true cash flow and fundamentals know the disconnect between actual cash flow and the market’s expectations for future cash flows borders on the absurd.
Netflix
Netflix NFLX, +0.16% has become one of the leading creators of original content, but it’s done so with an unsustainable cost structure. As this excellent video from The Ringer explains, Netflix earns an accounting profit, but only because its reported content costs understate its actual content spending by about 50%. The company continues to lose billions of dollars a year and grows increasingly dependent on the high-yield debt market.
Felix Salmon of Slate recently published a piece titled “Netflix Can Either Become the Dominant Media Monopoly of the 21st Century or Go Bust.” The market values Netflix as if it will be that dominant monopoly when, frankly, there’s a very good chance it goes bust. Risk/reward for this stock is so bad that no investor with any respect for fundamentals can own this stock in good conscience.
Salesforce.com
Salesforce CRM, +1.21% has racked up losses for years while pursuing growth at any cost. The theory behind this strategy is that the company will eventually be able to cut back heavily on its marketing and R&D costs while maintaining its recurring revenue stream.
Even if this strategy does work, which is far from certain, the company is currently valued at 10 times revenue, or double the valuation of Oracle. This hasn’t dissuaded bulls, as Salesforce generates classic tech bubble-style headlines like “Ignore Salesforce’s Valuation.” In other words, they want investors to ignore fundamentals.
Tesla
Tesla TSLA, -1.09% currently has a higher market cap than GM GM, -0.05% despite selling about 1% as many cars in 2017. What’s more, GM is already ahead of Tesla in self-driving technology and rapidly catching up when it comes to electric vehicle production.
Elon Musk keeps promising that Tesla will revolutionize the auto industry, but so far Tesla hasn’t shown an ability to navigate the manufacturing logistics that the established auto makers figured out decades ago. The company’s valuation is blind to fundamentals and seems entirely focused on the cult of personality that has built up around Musk.
Read: Tesla confirms intention to go private, sending stock up 11%
Spotify
Spotify Technology SPOT, -0.24% wants to disrupt the music industry, but so far it remains beholden to the Big Three record labels that own 85% of the music streamed on its platform. The market thinks of Spotify as a trendy tech company, but as we wrote in our report on the stock, the economics of its business are more similar to the movie theater industry.
Spotify’s leverage against the record labels is further weakened by the rapid growth of competitors like Apple Music AAPL, -0.08% It’s hard to see how Spotify can justify the growth expectations implied by its valuation unless it could pull off the unlikely feat of taking over ownership of its content from the labels while holding off competition from other streaming services (all without having to overspend like Netflix has).
Again, we see a company where the valuation reflects the best-case scenario with little to no tether to fundamentals.
How to bet against the micro bubble
Investors that want to bet against these micro-bubble stocks can short them directly, but that can be expensive and risky for these momentum-driven companies. As the saying goes, the market can stay irrational longer than you can stay solvent.
Another way to profit from the busting of this micro bubble is to invest in the incumbents from which these companies must take major chunks of market share. When these micro-bubble stocks fall back to earth, a great deal of capital should be reallocated to the incumbents.
Macro bubbles vs. micro bubbles
Today’s market has some micro bubbles, or smaller groups of overhyped stocks trading at ridiculous valuations.That makes it very different from the tech bubble, which was a macro bubble, a marketwide phenomenon that distorted the valuation of the entire market.
A few new features are shaping the market now and explain why today’s bubbles are unlikely to spread to the entire market, at least for the foreseeable future:
• Politicians and policy makers are focused on preventing macro market crashes. Today’s politicians and policy makers are heavily shaped by both the housing bubble of the mid-2000s and the tech bubble of the late 1990s. They will likely do everything in their power to prevent recurrence of such cataclysmic events on their watch.
• Rising influence of noise traders. Noise traders, who make investment decisions based on noise and have no regard for fundamentals, are an increasingly influential force in today’s market. Roughly a quarter of all U.S. adults with internet access are retail online traders. That’s around 50 million investors who don’t have professional trading (much less investing) experience and might be more susceptible to buying into “story” stocks without understanding the fundamentals. There’s power in those numbers.
• Overhyping “transformative” technology. The splintering of online media has led journalists to overhype nearly every new technology and trend in a relentless competition for clicks. For example, despite the “Retail Apocalypse” narrative, brick-and-mortar sales still account for 90% of retail sales, and Walmart earned nearly three times more revenue than Amazon last year. In reality, very few new technologies are as transformative as we like to imagine.
• Value transfer vs. value creation. Too many investors overestimate the value-creation opportunities for new technologies. Even when technologies are transformative, predicting who will reap the benefits of these technologies is difficult. Often, most of the value accrues to end users/consumers and not corporations. When it does accrue to a company, it’s usually at the expense of another company. During the tech bubble, bulls believed the internet would make our economy radically more productive and allow the GDP growth rate of around 5% in the late 90’s to persist for many years. When this utopian future failed to materialize, the market collapsed. By contrast, today’s micro-bubble companies compete against firmly established incumbents from which they must take large chunks of market share to survive. Instead of adding value, these companies aim to take value from existing players. Even if they succeed, we think much of that value will eventually pass to consumers.
This last point is key. In 1999, investors gave Microsoft MSFT, -0.10% its absurdly high valuation because they believed its software would create enormous amounts of value and growth for thousands of other companies. On the other hand, Tesla’s sky-high valuation implies it will take market share away from General Motors and Ford F, +0.50% which decreases the valuation of those companies.
These modern-day micro bubbles reflect the zero-sum nature of today’s crowded and more mature competitive landscapes.
Why we’re not in a macro bubble
Figure 2 sums up the difference between the tech bubble and today’s market pretty clearly. It shows the price to economic book value (PEBV) of the largest 1,000 U.S. stocks by market cap going back to 2000. PEBV compares the current valuation of a company compared to the zero-growth value of its cash flows, i.e. NOPAT, so a higher PEBV means the market expects more future cash flow growth.
While the market’s PEBV has more than doubled since 2012, from 0.7 to 1.5, it’s nowhere close to its tech bubble level of 5.7.
There are definitely some outrageously valued companies out there, but those high valuations … [more]
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august 2018 by neerajsinghvns
5 Stocks That Should Start Paying Dividends
5 Stocks That Should Start Paying Dividends
August 6, 2018, 9:37 PM EDT
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Investors tend to be drawn to hot technology and biotechnology stocks for their growth prospects - not for the cash they return to shareholders. But several well-known tech and biotech stocks could afford to invest in their businesses, buy back their shares and pay dividends, if only they chose to.
When it comes to returning cash to shareholders, corporate management often prefers stock buybacks to dividends because it gives them flexibility. A company can adjust its share repurchases according to business and market conditions. A dividend is a commitment. The market often exacts severe and swift revenge if a company cuts or suspends its payout.
The initiation of a dividend can also be taken as a sign that a company or stock's best days are behind it. A quick look at Apple's (AAPL) performance shows that's not necessarily the case. The company reinstated its dividend in 2012 after a 17-year hiatus. Between price appreciation and payouts, Apple stock has delivered a total return of about 170% since March 2012, when it announced plans to reinstate its dividend later that year - the Standard & Poor's 500-stock index is up about 130% over the same span, including dividends.
The following five stocks don't yet offer dividends, but they should ... and could. Each has the cash-generation ability to start a regular payout without giving up on share repurchases and investments in future growth.
SEE ALSO: 53 Best Dividend Stocks for 2018 and Beyond
Adobe Systems
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Market value: $124 billion
Analysts' opinion: 15 strong buy, 1 buy, 7 hold, 0 sell, 0 strong sell
Adobe Systems (ADBE, $253.28) has long been dominant in its niche of providing software for designers and other creative types. Photoshop, Premiere Pro for video editing and Dreamweaver for website design are just some of its hit products, and its shift to delivering them through cloud-based subscription services is generating tremendous growth.
Revenue is forecast to rise 22% this year and 19% next year, according to a survey of analysts by Thomson Reuters. Earnings are expected to increase at an average annual clip of 24% for the next half-decade.
Investors aren't clamoring for a dividend with that sort of torrid growth on the horizon. And it's not like Adobe isn't returning cash to shareholders already. It spent $1.6 billion on stock buybacks over the 12 months ended June 1, according to S&P Global Market Intelligence. But it could afford to give them more.
Even after share repurchases and interest payments on debt, Adobe generated free cash flow - the mother's milk of dividends - of $2.6 billion during the 12 months ended June 1.
SEE ALSO: 39 European Dividend Aristocrats for International Income Growth
Alphabet
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Market value: $861.4 billion
Analysts' opinion: 24 strong buy, 4 buy, 2 hold, 0 sell, 0 strong sell
Alphabet (GOOGL, $1,238.16), the corporate parent of Google, is another technology giant with such outsize growth prospects that it can get away with not paying a dividend.
But the fact remains that it easily could - even after European regulators hit it with a record $5 billion antitrust fine.
The search giant's revenue is forecast to increase 23% this year and 19% next year, according to Thomson Reuters data. Earnings are expected to increase at an average annual rate of 18% for the next five years.
Alphabet is plowing investments into the next big things. It has artificial intelligence, machine learning and virtual reality in its sights, and it's already a major player in cloud-based services. But it's still swimming in cash.
The company had $102 billion in cash and short-term investments as of June 30 and just $3.9 billion in long-term debt, according to S&P Global Market Intelligence. Alphabet bought back $6.3 billion of its own shares over the 12 months ended June 30, and still generated $22 billion in free cash flow, so it clearly has the financial means to initiate a dividend without risking its R&D.
SEE ALSO: The 10 Best Dividend Stocks of All Time
Biogen
Courtesy Citizen Schools Photo via Flickr
Market value: $69.0 billion
Analysts' opinion: 17 strong buy, 1 buy, 7 hold, 0 sell, 0 strong sell
It might be time for Biogen (BIIB, $344.21) to start paying a dividend.
It wouldn't be the first big biotechnology stock with slower growth prospects to do so. After all, peers such as Amgen (AMGN) and Gilead Sciences (GILD) pay dividends with yields of 2.7% and 2.9%, respectively.
A dividend also could help smooth out some of the volatility that BIIB investors have had to deal with. Mixed results from a mid-stage clinical trial of Biogen's promising Alzheimer's drug made July a month to remember. Biogen rose more than 30% between June 29 and July 25 ... but the stock is down by double digits ever since.
Expected top-line growth isn't as explosive as Alphabet and Adobe, at just 7% this year and 3% next year. Annual long-term earnings growth is promising, though, at nearly 8% for BIIB, according to Thomson Reuters.
Biogen bought back $3 billion of its own stock over the 12 months ended June 30, while generating $3.9 billion in free cash flow even after paying interest on debt. Biogen certainly can afford to return more cash to shareholders.
SEE ALSO: 10 Double-Digit Dividend Growth Stocks to Shield Your Portfolio
Booking Holdings
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Market value: $98.4 billion
Analysts' opinion: 15 strong buy, 4 buy, 8 hold, 0 sell, 0 strong sell
Booking Holdings (BKNG, $2,029.71), the online travel website operator formerly known as Priceline.com, has sturdy growth prospects, but it's not like they're accelerating anymore.
Analysts expect earnings to increase at an average annual rate of 14.7% for the next five years. That compares with average annual earnings growth of 15.6% over the past five years - in other words, good, but slowing down. Revenue is forecast to rise 19% this year and 12% in 2019.
Booking's strategy of growth through acquisitions and investments hasn't precluded it from buying back its own stock - or generating ample free cash flow. The company repurchased $2.3 billion in BKNG shares in the 12 months ended March 31. It also generated $3.4 billion in free cash flow after paying interest on debt.
Booking's shareholders aren't clamoring for a dividend, but it absolutely could afford to initiate one. That would ensure a little extra total return and perhaps tamp down what historically has been a relatively volatile stock.
SEE ALSO: The 7 Highest-Rated Dividend Aristocrats
Facebook
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Market value: $515.9 billion
Analysts' opinion: 25 strong buy, 3 buy, 2 hold, 0 sell, 0 strong sell
Facebook (FB, $177.78) set a record for the most market value wiped out in a single trading session when the stock lost 19%, or $120 billion, on July 26. That came on fears that it has entered a new era of slower revenue growth and narrower profit margins. Shares have drifted lower ever since.
Earnings that have grown at an average annual rate of 64% for the past five years are now expected to rise "only" 21% a year for the next half-decade. Revenue is forecast to increase 37% this year, but "just" 25% next year.
If Facebook's days of outrageous growth (relatively speaking) really are over, one thing it could do to sweeten the pot for its stock is to start paying a dividend. It has more than enough firepower to do so and still pour resources into acquisitions, research and development.
Facebook had $42.3 billion in cash and short-term investments as of June 30 - and no long-term debt against it. It bought back $6.7 billion of its own stock during the 12 months ended June 30, while generating $11.3 billion in free cash flow. Returning some more of that cash to shareholders could go a long way toward rebuilding faith in Facebook stock.
SEE ALSO: 8 Great Dividend Stocks Yielding 8% or More
EDITOR'S PICKS
53 Best Dividend Stocks for 2018 and Beyond
Millionaires in America: All 50 States Ranked
20 Best Small-Cap Dividend Stocks to Buy
Copyright 2018 The Kiplinger Washington Editors
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august 2018 by neerajsinghvns

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