'Vision and Growth' Won't Cut It Anymore
Editor's note: It's an unmistakable sign of the top...
As Extreme Value editor Dan Ferris noted in yesterday's Masters Series, we've seen a flurry of weird, unprofitable companies going public over the past couple of years. He called it the "Fear Factor IPO" market – where investors who require profits are labeled cowards.
Today, we're sharing more of Dan's recent commentary. In this essay – which first appeared in the September 13 Digest – Dan explains why he just changed his mind in a big way... what it means for the market over the next several years... and why owning shares of the "top dogs" won't save you as the coming bear market plays out...
'Vision and Growth' Won't Cut It Anymore
Ours is a funny business...
Folks pay financial-newsletter writers like me for our advice. But when we change our minds, they tend not to like it. It's like they hired us to defend a certain viewpoint come hell or high water, and not to think, learn, and share the benefits of our studies and experience.
Just remember, doing financial research and giving advice is a business. And as Rory Sutherland, vice chairman of ad agency Ogilvy UK, said in a recent article in the Spectator, "Business is the only area of human activity where you get paid to change your mind."
Architectural critic Reyner Banham went even further: "The only way to prove you have a mind is to change it occasionally."
You are paying us to be better at changing our minds than other folks in finance.
Try to remember that next time you feel a little betrayed by someone like me when I leave an old viewpoint behind and adopt a new one.
You shouldn't merely tolerate it when we change our minds... You should demand it. You should place a high value on it, because like I said, that's ultimately what we're paid to do. With that warning, I need to make clear...
I've changed my mind in a big way recently...
I now believe the big technology companies and other stocks that have made folks a ton of money over the past several years have peaked.
I talked about the details of the change I'm seeing in the September issue of my Extreme Value newsletter. But at its heart... I believe the market's fascination with "growth and vision" is over. Let me explain...
I loved my colleague Matt Weinschenk's recent skewering of The We Company...
Also known as WeWork, it's that goofy, money-losing, workspace-sharing company.
Matt really nailed it in his September 5 Digest. But I'd like to add one more point... The market for "vision and growth" initial public offerings ("IPOs") is dead. WeWork killed it by trying to go public at 15 times revenues, even though its operating losses have grown apace with revenues the last few years.
Given that it operates 528 locations in 111 cities in 29 countries, it's looking like the business will never scale and it will lose money with every new property it opens despite attempts to "make it up on volume." Sam Zell, who made billions on real estate projects that generated actual positive cash flow, recently told CNBC that every single company that's ever been in that business has gone broke.
The U.S. arm of WeWork's lone public peer, London-based IWG, went bankrupt in 2003. Today, IWG trades for around 1.4 times sales, which would put WeWork's value at less than $5 billion. That's roughly 10% of the $47 billion WeWork garnered during a round of private financing earlier this year and less than half of the $11 billion its largest investor, Japan-based SoftBank, has committed.
Vision, rapid revenue growth, and huge losses used to be enough to get you a multibillion-dollar IPO...
Uber (UBER) went public in May with a valuation of $8 billion, making it one of the 10 biggest IPOs of all time. It immediately posted a $5.2 billion quarterly loss (its largest ever), and shares are down about 35% from the IPO price. Uber barely skated into life as a public company. If it tried to go public today, the valuation would be so much lower that the deal would probably fall through.
Vision, growth, and massive losses won't cut it anymore. From here on out, you'll need an actual business if you want to go public. I suspect this will put a real damper on the IPO market. We'll see.
On a related topic, Stansberry Conference attendees, Extreme Value subscribers, and Stansberry Investor Hour listeners will all recognize another theme I've been harping about for the last year or two...
The most popular stocks will be lousy performers in the next downturn and over the next several years...
In yesterday's Masters Series, I shared the example of Internet "plumbing" provider Cisco (CSCO). It was the No. 1 darling of the dot-com era, then lost 90% of its value after the bust and still hasn't recovered to its dot-com peak.
My friend, investor and author Vitaliy Katsenelson, recently published a piece about a similar scenario set to unfold soon...
Vitaliy explained that Cisco got crushed in 2001 after many of its dot-com customers went bust. That caused a sharp drop in revenue, which led to a dramatic plunge in its share price.
He notes that many Silicon Valley startups today must use large chunks of their venture-capital proceeds to advertise on Facebook (FB) and Alphabet's (GOOGL) Google in order to maintain the high growth they need to go public. When they all go bust, Facebook and Google will lose those revenues.
Vitaliy freely acknowledges Facebook and Google aren't nearly as expensive today as Cisco was at the dot-com peak... but he still believes declining revenue growth will lead to lower valuations.
I'm sure many will push back against this idea. But I'd say they suffer from what famed investor and author Howard Marks calls "a lack of imagination." No one today can imagine that Facebook, Apple (AAPL), Amazon (AMZN), and Google won't keep growing and dominating markets endlessly.
But just look at some of the financials of companies that have filed for IPOs...
SmileDirectClub (SDC), the mail-order orthodontics company, is one. Its revenue grew from $140 million in 2017 to $398 million last year – a 184% increase. (Growth!)
It promises to cut the cost of orthodontics by as much as 60%. (Vision!)
But a glance at the company's income statement shows marketing and selling expenses are growing even more – about 231%.
This makes me wonder how much of that was spent with Facebook and Google. If SDC doesn't become profitable soon, the marketing budget could suffer. It's no surprise to me that SDC's stock – which began trading on September 12 – opened at $20.55 per share, below its $23 IPO price. Today, it's only trading at about $10.25 per share.
Peloton (PTON), WeWork, Pinterest (PINS), and Zoom Video Communications (ZM) all saw marketing expenses outpace revenue growth in the period just before filing their IPO prospectuses. All reported lots of revenue growth... All have a vision of connecting us or something equally flowery and benevolent-sounding... But none report profits.
If they all go bust, those marketing budgets will disappear. It's just a few hundred million dollars or so... But a lot of other companies out there want to go public or recently went public.
Ernst & Young reports a record number of "unicorns" – private, venture-capital-backed companies valued at more than $1 billion – went public in 2018. The trend which continued into the first half of 2019. The accounting and consulting firm also reported...
The number of unicorns that came to the public markets in Q2 2019 suggests IPO candidates are either finding an open IPO... There are several more mega IPOs and unicorns waiting in the wings, as well as a robust pipeline of small- and mid-cap IPOs across all regions.
That report was through the end of June. How much do you want to bet Uber's garbage results and the failure of the WeWork IPO have shut the window tight?
My take remains simple (I'm not smart and sophisticated like Vitaliy)...
The best businesses won't save you in a bear market...
Everybody knew those were the greatest businesses and bid up their shares.
Analyst Rob Arnott of Research Affiliates recently described how the greatest businesses in the world can underperform in some research his firm conducted.
His group looked at an elite group of companies called "top dogs." These companies have the biggest market caps in the world or in a particular country. Bottom line... They consistently perform poorly once they become top dogs.
Remember when Apple became the first company with a $1 trillion market cap? It peaked shortly after, fell more than 30% rather quickly, and is only now getting close to its all-time high again.
Today, another top dog is Microsoft (MSFT). It's as wonderful a cash-gushing business as you could ever hope for. But don't count on making a ton of money over the next several years if you buy its stock at the current level.
Top dogs or not, the market clearly doesn't care what I think...
Apple rose 3.2% recently when it announced new product offerings, including its TV+ streaming service, priced at $4.99 a month. Streaming dominator Netflix (NFLX) charges $12.99 for its standard service... and generates negative cash flow doing it.
(Streaming is the weirdest thing. I can't remember so many gigantic technology companies falling over each other to get into a business where nobody is making any money. But what do I know? I'm still in the dark ages, buying songs on iTunes and feeling like it's perfectly OK.)
Apple failed to raise the price of its latest iPhone for the first time in years. And it now offers a new entry-level model for $699.
Sooner or later, prices start to matter. Having swatted Nokia and Blackberry away easily, Apple's competition is now Chinese manufacturer Huawei and Korea's Samsung. Huawei is gaining ground, having increased market share as its two competitors have lost some. The Financial Times reports...
Huawei is in a strong position, catching Apple and closing on Samsung in terms of smartphone shipments. More pertinent, perhaps, is the fact that in the first half of this year, its smartphone market share has risen at Apple's expense.
Of course, the real top dog in financial markets today isn't a stock at all – it's a bond...
Actually, it's the entire global bond market—the biggest bubble I've ever seen in my life.
Though it has fallen a bit recently, it still features nearly $15 trillion – with a "t" – of bonds with negative yields to maturity. If you buy them at current prices and hold them to maturity, you'll have paid more than all the interest and principal. In short, you're guaranteed to lose money.
Bloomberg says the U.S. corporate-bond market had the best August in 40 years. If you're a European bond-fund manager, you're probably having a career-making year right now. Bonds of all types have been in a bull market since about 1981. If you remember losing money in bonds, I don't want your financial advice, I want to know how you've lived so long!
The market demandeth... and the European Central Bank ("ECB") giveth. The ECB recently lowered its deposit rate from -0.4% to -0.5%. The ECB is also restarting quantitative easing ("QE") in November, when it will begin buying €20 billion of bonds every month. It's the restart of a previous QE program, under which it bought €2.6 trillion before halting purchases last December.
I've been talking about the bond bubble on the Stansberry Investor Hour with macro investors like Cullen Roche and Kevin Muir. Both agree bonds are a massive global bubble and the move from positive to negative yields has turned otherwise safe investments into risky, speculative bets (which I refer to as "toxic waste").
Roche counsels caution and says it's a tough time for investors today. He expects the global economy to muddle along for some time.
Muir agrees, but sounded a bit more sanguine. He said bond prices will fall... but for "good reasons," i.e., that the global economy will grow enough that folks will sell bonds to buy stocks and other riskier instruments.
Predictions are hard... especially about the future, as New York Yankees great Yogi Berra said. I like the idea of being cautious on both stocks and bonds right now... But I've liked it since about May 2017, when I started getting worried about equity valuations and first noticed investors' infatuation with the "vision and growth" market.
These guys know a lot more about macro situations than I probably ever will. But I'm still worried that U.S. stocks are just so darn expensive that they're due for a rather steep drop in the next couple years.
The benchmark S&P 500 Index rarely trades north of two times sales. The only other time it hit that level was around the dot-com peak. It's around 2.2 times sales today – lofty territory by any measure. Price-to-sales correlates better than most measures with subsequent returns. When it's high (like today), returns will be low and vice versa.
Good investing,
Dan Ferris
Editor's note: On September 9, something happened in the markets that will affect everything... whether you realize it or not. You could be in for a rude awakening if you get your next move wrong. But you don't have to be a victim... Dan just released an urgent warning to help you survive – and even thrive – as this shift happens. Learn more here.