By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Testosterone Pit.
The theory is this: if certain stocks plunge far enough, it’s a buying opportunity because they’ll go back up someday. Assuming you’re patient and liquid enough, that theory works marvelously for those stocks that do go back up someday.
But plenty of stocks don’t. Momentum stocks – with a few exceptions – belong to that group. Once momentum hisses out of them, they deflate for good. All the hype and smoke and mirrors and hoopla that the fawning media eagerly transmitted from Wall Street and Silicon Valley or Silicon Alley or whatever to the public suddenly look silly. And afterwards, the mere sound of their names causes a flurry of raised eyebrows and shaking heads and some wistful smiles.
To make momentum stocks fly, the promoters doll them up in newfangled metrics and “estimated adjusted future earnings per share,” or some such pro-forma nonsense, or even “adjusted earnings per share,” or earnings “ex-items,” which aren’t earnings at all, but fantasy numbers, though by now everyone is using them. And to heck with the old-fashioned metrics like revenues and actual earnings as reported under GAAP.
On November 6, just before Twitter’s IPO – which was shrouded in even thicker than usual layers of hype, smoke and mirrors, and newfangled metrics – the SEC warned about newfangled metrics. They were designed, Chair Mary Jo White said, “to illustrate the size and growth” of these outfits that lacked outmoded results, such as actual profits, or even hope for actual profits. She strenuously avoided mentioning Twitter by name, tough everyone knew that’s what she was talking about. She and her staff were particularly concerned that “the true meaning of the metric (or more importantly the link from metric to income and eventual profitability) may not be clear or even identified.”
Wall Street ridiculed the warning, and Twitter soared to $74.73 by the end of the year. Now reality has set in. The SEC has proven its point. There are no actual GAAP earnings in Twitter’s foreseeable future. And the stock crashed 55% from its high. But what is a company worth to its shareholders if it cannot ever make any actual profits and simply eats up investor money?
Twitter is just the tip of the iceberg. Entire sectors have been demolished over the last few months. But the hype mongers on Wall Street are touting Internet stocks as a buying opportunity, as if this ongoing fiasco were some kind of ephemeral dip, a unique opportunity to get in at the right price for long-term prosperity. In that spirit, Citigroup pumped internet stocks.
So the FDN Internet Index fund is down 16.2% from its peak on March 5. Citi’s own large-cap Internet index is down 18%. But here it goes, Citigroup analyst Mark May in a note to clients:
We believe the recent pullback represents a particular opportunity among large cap Internet stocks, with multiples having retraced to levels not seen for more than two years, with no/little change in fundamentals, and with investment profiles that sync well with what portfolio managers are seeking in today’s market.
Citi’s clients are presumably not day-traders trying to take advantage of short-term swings, but portfolio managers trying to build and maintain wealth through prudent investment choices. Among his favorites: Facebook (-17.6% from its high), Google (-11.9% from its 52-week high), Amazon (-25.3%), AOL (-30.9%, so it’s “particularly oversold”), or even LinkedIn (-42.7%).
These and hundreds of other momentum stocks have swooned while the Dow and the S&P 500 indices have set new highs. What will happen to these stocks when the Dow and the S&P 500 begin to swoon as well? And why would these stocks now suddenly be such great buys, after they’d been excellent buys all the way up, and at much higher prices, and then all the way down? Because analysts have a job to do: hype the stocks they’re assigned to hype.
“Despite the pullback in valuations, the fundamentals of large cap Internet companies haven’t changed,” May wrote. Sure, the fundamentals, as expressed in estimated adjusted future earnings per share and the kinds of newfangled metrics the SEC had warned about, may not have changed, but reality hasn’t changed either, and investors have started paying attention to it just one tiny bit.
This is like so 2000. Back then, even as the hot air was hissing out of momentum stocks, there were enough powerful rallies to infuse a sense of hope and allow some lucky traders to make some money. And these heroic analysts rode the market all the way down with their hype and encouraged people to lose 50%, and often much more, of their investments just so Wall Street could wring out its fees.
Once the hot air is gone, momentum stocks become shipwrecks. Some of them sink to the bottom of the ocean. Others stay afloat for years, listing, drifting, nearly worthless. Some of the survivors cobble together a functional business model, make actual money, and perhaps even thrive years down the road. And a few, such as some of the large-caps mentioned, have impeccable business models and actual earnings, but their valuations simply make no sense, not even at todays lowered prices. But analysts would likely be fired for even thinking that.
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When Wall Street does false advertising it’s OK. The government blesses the behavior by not prosecuting it.
There were books with titles like “Dotcon” yet the role out the same bent model again. I can’t see even companies like Google are worth much, or even won a fair commercial battle with alternatives. The advertising model may well be a dud and lucrative US subsidies may have helped establish market dominance.
Stupid as it seems, I must admit I don’t know where the lost money on these stocks goes – who ends up skint? I’m not a standard consumer, but I can’t remember being influenced by any net advertising, watch commercial television on 20 minute delay and am about to use something other than gmail because I’d rather pay than suffer their intrusions. Stuff gets popular by being free or very low cost, or like Anaplan embodies skills that cut jobs almost like offshoring.
What scares me is no plan for the very different lives and world we could have.
Google is most certainly worth money. It is handsomely profitable and has a near monopoly on internet search and the ad dollars that go with it. They made something like $3.5 billion dollars in the first quarter this year.
As to who loses money in the stock fluctuations? It is likely spread across sectors, though others can comment. Mutual funds hold stock, individual investors hold stock, hedge funds hold stock. The losses aren’t realized until you sell something at lower value than you bought though.
I also don’t think this bubble is at all like the first tech bubble. The IPO generation is much lower and investors generally are more skeptical of these companies business models. It seems that PE investors and other rich fools are getting taken for a ride in this tech bubble. They’re all hoping that their non-profitable company will get acquired by one of the legitimate cash generating firms. So they throw money at a host of stupid companies that make no money in the hopes that one of them will be the next WhatsApp or Tumblr.
Moreover, I think we would expect a bubble in a sector like social media apps and internet software. It’s clear that ad dollars are going online and will continue to do so. Whoever figures out the formula of engaged billion + users and ads will generate a lot of revenue. So Investors are throwing money at companies with ideas, trying to get in on the ground floor. And these companies become profitable relatively quickly and require much less capital to start.
I’m familiar with the biotech sector where you need a great deal of capital and time to generate a successful product. And your chances are very, very low of ever doing that. And yet people do invest their money into VC firms and PE funds that start up small biotechs.
The credulous end up skint.
Back around 2000, an acquaintance who was an extremely unsophisticated investor with $$ in their eyes informed me they had just bought a block of some high flying internet stock (infospace maybe?). This guy knew nothing about the stock market – he ran a small pizza restaurant – but he was suckered by all the hype that was dificult to ignore. He was already counting the profits, telling me he was going to rake in big $$$ because the stock had quadrupled in recent months so by next year at this time his shares would be worth …….
That didn’t work out so well for my acquaintance. It likely worked out very well for the insiders given special access to the IPO who later dumped their shares on people like this.
Value?
Economic Value?
Focus on the future?
Pro forma?
My 22 year old son wants to make millions. I tell him try making $500 today.
The bond market smells a rat. Rates are dropping despite all the hoopla of better times just ahead.
Whatever is out there lurking in the weeds is something big that can’t be contained by the propaganda machine.
They are all worried that some loose cannon is going to tell the truth: that we simply have a much larger available labor force than what is needed to run the businesses of the world.
You can only flim-flam for just so long before the smoke and mirrors no longer work. Everyone is waiting for what happens when J6P finally realizes that he’ll never work again. He’s now excess labor in a market that has no use.
When everyone realizes that this is the new normal and there is no job recovery, the shit hits the fan.
Dino, Doug Noland posted an article on both the drop in “momentum stocks” and developments in the bond market that I found worthwhile: http://www.safehaven.com/article/33741/no-conundrum-20
At the same time, I see that rail traffic nos. published by aar.org are rising across most categories of shippers, and Canadian rail shipments are increasing.
Thank you for the reference. Like Mr. Noland, I can’t quite put my finger on it. Geopolitical, debt implosion, unrelenting deflation, or revolution, take your pick. Bond prices are going up nonetheless because the big money is seeking a safe haven in a gathering storm.
Inquiring Minds
Through normalization, public education and law enforcement in public housing, the empire moves debt as money, hiding the paper debt conversion to asset, with the willing participation of the majority bred on debt to do so, which ‘needs’ to belong to a peer pressure group as security. If you need a doctor to have children, you are screwed right from the beginning.
The empire labor market isn’t any more real than the S&P is a real stock market. Buffet doesn’t care about beating S&P inflation normalization, so long as he matches it with others, and that’s pretty easy considering their vertical collection of regulated-in monopolies. He can post any numbers he wants. Davos is about deciding what numbers to post.
If you look at real household budgets, you will see the transferred cost of technology and tax inflation, the magical wealth effect. On the horizon being crushed you will see the homeless, who still believe they are homeowners, watching their real disposable income get crushed in the VIX margin ratchet. For the upper class with rent leverage, the problem solution is still the solution. The only reason it is voicing concern is because the cliff edge is collapsing toward it.
Let’s see, the banks won’t touch land, but will be happy to issue another mortgage for cash, debt as money, until the refi-flippers bankrupt themselves in the process of chasing debt. Might want to get a job at a university hospital where all that debt is colliding.
And what do you suppose those critters slicing and dicing down to the individual psychographic are doing with all that data in the cloud? How many times have the French sold their own to Germany? Who/what can cross borders freely, who/what can cross at a price, and who/what cannot cross at any price? What do you suppose the Cold War was about? Do you really think that the empire is organized into nation/states, or just its version of labor?
What does the Snowden timeline tell you about how the event horizons operate?
Rigged is a relative term, to the automatons benefiting from the outcome.
Sorry; there is no Santa Claus.
The empire stitches consumer peer pressure horizons, grown in national farms, across borders, training them to consume beyond production and seek free crap to make up the difference, convincing them that a national government printing its own paper cannot go bankrupt, enacting ever more laws to chase down those terrible 1% productive individuals, into ever smaller legal borders, to complete the circle. Funny, the laws don’t apply to the landed class, or the upper middle class serving as the example to those below, in the ponzi lottery.
That’s why labor is always building two transmission mechanisms ahead, leaving a third behind for the empire. The Internet is just a more efficient version of something labor left behind decades ago, as is Facebook, which is why the empire cannot make it work. World wars occur because the empire consumers strangle themselves with debt, misallocated capital, assuming the empire is all powerful, and the producers have no exit. Legacy takes the income during the demographic boom and the land back in the demographic collapse, growing in both directions, until it collapses.
Greece and the others have all seen this show many times, over thousands of years.