In the Next Wormhole, We'll Crash Back to Reality

A genius retirement plan for Yoda – or maybe not... A wormhole into the distant future... The rise and fall of Kodak... From film to cryptos to generic drugs... A 20-bagger in two days... In the next wormhole, we'll crash back to reality...

At first glance, it seemed like a genius retirement plan for everyone from Yoda to Methuselah...

All two of them.

Someone on Twitter recently pointed out an absurd statistic about e-commerce firm Shopify (SHOP). I (Dan Ferris) believe it's a classic example of the times we're living in...

This Twitter user suggested that Shopify's stock currently trades for around 870 times the most generous possible measurement of the company's 2021 earnings – the ratio of its enterprise value to earnings before interest, taxes, depreciation, and amortization (EV/EBITDA). An EV/EBITDA ratio of around 870 implies that it could take 870 years for your initial investment to pay off.

Nearly nine centuries is a long time to wait to be rewarded on your initial investment. It takes a special kind of investor to patiently wait that long... Mostly, it takes someone who can live that long in the first place, which narrows the potential shareholder base quite a bit.

That's why I immediately thought of Yoda and Methuselah...

According to the Book of Genesis in the Old Testament, Methuselah lived to age 969. The grandfather of the ark-building Noah is the longest-living person mentioned in the Bible.

And Yoda, the little green Jedi master from the Star Wars movie franchise, lived to be exactly 900 years old before his body disappeared and he became "one with the Force" in Return of the Jedi. (Oops, sorry, I always forget to include the spoiler alert.)

I'm not sure who else can own this stock and expect to see their investment pay off. I'll have to comb through all my science-fiction novels and read the Old Testament again.

Regardless, somebody needs to take care of people like this in retirement. I mean... what if they become disabled at only 150 years old? How would they spend the next 720 years?

Despite Shopify's implied payback period of nearly nine centuries, maybe it could be the answer...

If Yoda's parents had bought Shopify shares at his birth, he likely would have gotten his money back by his 870th birthday... and lived high on the hog for the next 30 years.

A one-stock retirement plan fit for a 900-year-old Jedi master. No muss, no fuss. Just buy one stock... wait 870 years... and you're golden. Except for one teensy-weensy detail...

After reading the original tweet, I looked closer at Shopify's financials.

And as it turns out, the original person who posted on Twitter missed a small-but-critical detail... a negative sign. You see, Shopify's current EBITDA is actually negative. The company isn't making money at all... It's losing $40 million per year at this point.

In reality, Shopify's stock doesn't trade at 870 times the most optimistic version of its earnings today. It actually trades at around 850 times its losses.

But I guess if Shopify finally starts making money next year, the Yodas and Methuselahs of the present times stand a chance at a comfortable retirement in another 869 years or so.

Although it didn't work out as planned, I still feel like I'm onto something with this Yoda gag...

With stock valuations in outer space today, the realm of science fiction seems like fertile ground for equity analysts.

My friend, investor and author Vitaliy Katsenelson, seems to agree... at least in regard to the object of cult worship known as Tesla (TSLA).

Vitaliy recently published an essay on his ContrarianEdge website titled, "Tesla's Stock Price Discounts Temporal Wormhole Into the Future." He invoked sci-fi TV series Star Trek in his write-up to explain the electric-car maker's exorbitant market valuation...

In Star Trek there are convenient wormholes, which cut corners through space, getting you to that galaxy a billion light years away in hours. Low interest rates have messed with the temporal properties of the market and created a wormhole in time and in Tesla's stock... It will take years, maybe even a decade, for Tesla to produce enough cars to justify its valuation. Today's market valuation assumes it has already happened – that the capital has been raised and spent and that it cost nothing.

I've had similar thoughts about the stock market as a whole...

The market sets the prices at which sellers and buyers agree to trade shares. Whether investors and traders are aware of it or not, the act of setting those prices involves discounting... a term that means they must figure out the value of a business.

I won't get into all the math in today's Digest... But when the market assigns valuations far in excess of the intrinsic value of a business, it's not properly discounting.

That's why Vitaliy says Tesla is discounting a "wormhole into the future"... The market is behaving as though all the earnings between now and some distant time period are already on the books and are deliverable into shareholders' hands right now.

The problem is, in some not-too-distant future, the dramatically overvalued companies will stop being dramatically overvalued... and their stocks will crash in remarkable fashion. The market will travel back in time, eliminating entire years' and – if stocks are egregiously expensive enough – decades' worth of overvalued earnings from company valuations.

Obviously, we're not at the latter point in time yet because the market isn't crashing today. It's back near all-time highs... We've stepped through that wormhole into the distant future.

We've arrived at a time when Yoda's great-great-grandchild is blowing out 870 candles. And Tesla is celebrating its first year of making 10 million cars... Vitaliy said that's how many it needs to make to justify its current valuation. (It makes fewer than 400,000 per year now.)

Shopify and Tesla aren't the only examples of egregious excess in the market today...

Taking it a step further, centenarians aren't the only beneficiaries of this excess in the market. And mere time travel isn't the weirdest way of thinking about it all.

In at least one case, it looks like a government lending program is attempting to channel the late Ursula K. Le Guin's The Lathe of Heaven. In the sci-fi novel, the protagonist George Orr's dreams erased the actual past, leading to a different present when he wakes up...

For example, as a teen, Orr dreamed that his aunt, who lived with him, died in a car crash. Then, he woke up and she was gone... and he remembered her dying six months earlier.

But of course, Orr isn't an actual person... and The Lathe of Heaven isn't a nonfiction work.

No matter what dreams investors may have today, they can't erase the recent past of has-been film dominator Eastman Kodak (KODK). And now, like with Tesla, Kodak's stock price discounts a wormhole into a highly uncertain – and I'd say improbable – future...

As a kid growing up in the 1960s and 1970s, I didn't have the luxury of digital photography...

As I'm sure many folks reading this Digest can attest to, our cameras needed film back then to work.

When you took all the pictures you could with a roll of film, you took it to the local drugstore and had the film developed. You waited a week or so before getting your pictures back.

And when you needed more film for your camera, you bought Kodak film. I don't even remember other brands existing. Kodak was far and away the market leader. In 1976, for example, Kodak reportedly sold 90% of the film and 85% of the cameras in the U.S.

It was the perfect "razor and blade" business model. But the company's big margins came from its film sales, not its camera sales. And you couldn't use a camera without the film... So the more you used your camera, the more film you needed to buy.

As a result, Kodak thrived for decades.

But then, in 1984, Kodak's faith in its own brand inspired a colossal mistake...

Kodak was offered the opportunity to become the "official film" and one of the title sponsors of the 1984 Olympics in Los Angeles... And it declined.

Instead, Japanese rival Fuji landed the Olympics sponsorship and forever changed history. With its name now in front of millions of Americans, the company thrived... By 1995, Fuji had made major inroads into the U.S. film market, which Kodak had dominated for years.

Then, digital photography came along and essentially eliminated the need for film.

It's ironic that digital photography put the final nail in the coffin for Kodak... because Kodak invented the first self-contained digital camera way back in 1975.

Of course, Kodak didn't fall apart overnight... In fact, it was No. 1 in U.S. digital-camera sales by 2005. But it proved too little too late... And it mostly lost money selling digital cameras.

The business model just wasn't the same. There were no more blades for Kodak to sell, just razors with blades that never needed changing.

Besides the inferior business model of selling digital cameras, Kodak's failure to capitalize on the shift was also rooted in its fear of cannibalizing its traditional film business. Kodak didn't see the writing on the wall for traditional film... even though it was doing the writing.

Kodak entered bankruptcy in 2012 and emerged the next year as a shell of its former self. In its heyday, Kodak had 145,000 employees. Today, it employs less than 5,000.

But Kodak hasn't gone down without fighting – or at least without flailing with a couple of weak punches...

First, in January 2018, Kodak announced its intention to create the KODAKCoin.

The company described the KODAKCoin as "a photo-centric cryptocurrency to empower photographers and agencies to take greater control in image rights management."

As you might recall, bitcoin had just soared to record highs of nearly $20,000 in December 2017... and investors were buying into the euphoria surrounding cryptocurrencies.

But on the flip side, the whole charade immediately reminded me of the gold-exploration companies that became dot-com companies overnight during the Internet boom in 1999.

Two years later, the KODAKCoin project is such a total flop that it's not even mentioned in the company's annual report. (Maybe Kodak's accountants read The Lathe of Heaven.)

Kodak was mismanaged and ultimately failed in digital photography. Its crypto foray was a desperate, failed attempt to seize upon investor excitement. But relax, all that failure is in the past.

You see, Kodak is ascendant once again – or so we're supposed to believe...

After the markets closed on Tuesday, Kodak announced that it will get a $765 million loan from the U.S. government. And more important, it'll use the loan for its new drug business.

Why the drug business?

Heck, man, why not? Cameras, film, cryptos, drugs... hey, it's all technology. Kodak built a storied history in cameras and film... and chemicals were once used to develop film... and drugs are chemicals. So, yeah, Kodak is going to be great at this new endeavor.

Kodak CEO Jim Continenza said the company will produce "starter materials" and "active pharmaceutical ingredients" for generic medicines. He pointed out that Kodak has a "long, long history in chemical and advanced materials – well over 100 years." (He's no George Orr, but that's not a bad effort of rewriting history.)

Of course, what it hasn't done for 100 years is go anywhere near the drug business. But I don't want to nitpick... Continenza said Kodak's new drug operation would "get up and running quickly." I doubt that comment will age well, but I certainly wish him the best.

Whether Kodak succeeds in its drug dealings or not, I can't help but wonder...

Why does the U.S. government want Kodak to get into the drug business in the first place?

To make the loan, the government invoked the Defense Production Act, a law passed at the beginning of the Korean War. All those laws they pass in Washington have popular short titles like the CARES Act or the Patriot Act... But they also have a long title, which tells you more about what's included in the law. The long title for the Defense Production Act is...

An act to establish a system of priorities and allocations for materials and facilities, authorize the requisitioning thereof, provide financial assistance for expansion of productive capacity and supply, provide for price and wage stabilization, provide for the settlement of labor disputes, strengthen controls over credit, and by these measures facilitate the production of goods and services necessary for the national security, and for other purposes.

Never mind the eerie implications of the last four words, which seems to turn this thing into a blank-check law. This bill is ostensibly for spending money on national security.

And which issues related to national security are folks paranoid about right now?

Well, in the U.S., we consume a lot of medicine that is made in China. And of course, we're not exactly best friends with China right now. Hence a $765 million loan to a U.S.-based company.

The market has apparently awakened to a new view on Kodak's past, too, but maybe that isn't saying much...

After all, the market also believes in wormholes and the perfect retirement plans for Jedi masters who live until they're 900 years old. But let's try not to rain on this parade, OK?

Kodak's stock closed at $2.62 per share on Monday, giving the company a market cap of around $115 million. It traded as high as $60 per share on Wednesday, the day after the loan announcement, giving it a market cap of more than $2.6 billion.

Nothing like a two-day 20-bagger to whet the speculative appetite!

On Wednesday, Barron's crunched a few numbers to try to get some idea of what Kodak's new business might be worth... if it succeeds. From the article...

Generic-drug makers take about $1 in assets to generate 40 cents in sales. Based on that, Kodak's fresh $765 million loan could bring perhaps $300 million to $400 million in sales. That would be worth, in theory, about $450 million to $600 million in market value.

Kodak's intraday high of $60 per share on Wednesday put the stock at more than five times the back-of-the-envelope estimate from Barron's. And more to the point, it's five times what the business would be worth... if everything goes swimmingly and nothing goes wrong.

Given the digital photography and KODAKCoin debacles, I can't imagine that will happen. (George Orr, please help with another one of your dreams... Kodak shareholders need you.)

So in less than a week, Kodak's stock rose as much as about 2,100%. And it was based entirely on a government loan and the idea that one of the great business failures of our time can pivot from photography into pharmaceuticals (after a brief failed dive into crypto).

In the blink of an eye, Kodak has catapulted from the gutter into outer space and through the temporal wormhole. Captain James T. Kirk couldn't have done better himself.

I also can't imagine being the person who ultimately decided to lend $765 million to Kodak...

The decision was made when Kodak's market cap was south of $100 million... And clearly, the left-for-dead company doesn't have enough assets or earnings power to justify the loan.

No banker would ever have done this deal. No Jedi master would ever do this deal. Heck, no one who has simply been to the movies or heard of money would ever do this deal.

For this kind of boondoggle, you need big government... "Government capital allocation" is the most revolting oxymoron. I wouldn't touch Kodak's shares with a 10-foot pole. Like I said, I expect this to turn out poorly... and much worse than the stock market currently believes.

This is what you get when the government decides that it's going to help us all out, good and hard, whether we like it or not.

The problem is, you and I don't have to live with government's ideals or intentions... We have to live with the actual consequences of its actions. I figure this consequence will be more wasted capital and another bankruptcy before the company ceases to exist forever.

I wonder if any of the decision-making buffoons in Washington will take any responsibility for enticing a bunch of Robinhood traders to buy Kodak shares... It's almost certain to end in tears for them. (And anyone who paid more than $25 or $30 per share is likely already crying about their losses... Kodak's stock dropped 27% today, closing at $21.85 per share – and yet, it's still about $800 million in market cap above Monday's close.)

By the way, I wonder if anybody will be charged with insider trading...

I promise you that somebody at the U.S. Securities and Exchange Commission has already noticed that the stock was up as much as fivefold on Tuesday... before the announcement.

I'm not accusing anyone of doing anything shady. I'm just saying that someone is guilty of something shady. Is that the same thing? I bet some lawyers could convince you it's not.

The sense of desperation at Kodak is palpable...

The company is resigned to touting its 131-year history to justify a Hail Mary pass from the government. It's pivoting into yet another business far outside of any core competency it might be said to have ever possessed – back when it was competent decades ago.

As a result, we're left with a stock that zero Wall Street analysts cover flying upward as much as 2,100% in a few days. And of course, the meteoric rise was likely propelled by stuck-at-home day traders who can't spell intrinsic value, let alone tell you what it means.

If anybody tells you the stock market is functioning just fine today, grab your wallet and run...

Yes, I fully expect that my colleague Steve Sjuggerud's long-awaited "Melt Up" is here. The stock market is surging higher despite a global pandemic and a rapidly shrinking economy.

We're living in a speculator's paradise. It's a time when learning a ticker symbol and hitting the "buy" button in your online brokerage account constitutes deep research.

Somewhere along the line, we stepped into a wormhole. But I believe another one lurks around the corner. And once we step into it, we'll be sent back to reality at warp speed.

Maybe we can get George Orr to dream that COVID-19 never happened... that clueless Robinhood traders never got the chance to go crazy because they had to go to work to earn money... and that stocks have been attractively priced the whole time.

For now, I suspect the market will rise higher than I ever would have guessed... However, when we hit the next wormhole, it'll begin falling to depths I could never have imagined.

New 52-week highs (as of 7/30/20): Agnico Eagles Mines (AEM), Digital Realty Trust (DLR), DocuSign (DOCU), Fidelity Select Medical Technology and Devices Portfolio (FSMEX), GrowGeneration (GRWG), LCI Industries (LCII), Lonza (LZAGY), O'Reilly Automotive (ORLY), Palo Alto Networks (PANW), Flutter Entertainment (PDYPY), Procter & Gamble (PG), Rollins (ROL), TFI International (TFII), Take-Two Interactive Software (TTWO), and Vanguard Inflation-Protected Securities Fund (VIPSX).

In today's mailbag, feedback on the 78% return in less than week for True Wealth Opportunities: China subscribers, which we mentioned in yesterday's Digest. As always, if you have any comments or questions, e-mail us at feedback@stansberryresearch.com.

We've also heard from many folks who missed Porter's "Capitalism in Crisis" presentation yesterday morning and want to learn about his latest prediction. If that includes you, we have good news... You can watch the full replay of the event right here.

"Great job on the China Newsletter. I made that 78% on SOGO this week.

"I run a US expat tax firm and it's via a HK company and I buy all those China stocks via my HK Interactive Broker's account.

"Love your research for 25 years now. Again, thanks." – Paid-up subscriber Michael M.

Good investing,

Dan Ferris
Vancouver, Washington
July 31, 2020