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Be Wealthy & Smart

Jul 26, 2017

Learn how tech stocks get ahead of themselves sometimes and how not to get burned.

Stocks got ahead of themselves in the year 2000 and it took 17 years to get back to where they were! Bubbles can create unreasonable valuations that are very extended because investors invest by betting on their success in the future and ignoring the outrageous valuations of today.

Just like today we have FAANG stocks, in 2000 - the “Four Horsemen of the Internet” - Intel, Microsoft, Dell, and Cisco Systems.

Back in the year 2000, what drove them is the “Y2K” scare, only people didn’t realize it. They thought is was the “New Economy”. It was about “eyeballs” and “bricks and clicks”, not earnings and profits.

This can happen for an extended period. Investors get caught up in the next “new thing”.

They forget it has to make money!

Earnings growth is what drives stock prices! Investors buy stocks in anticipation of future earnings growth, but it can get out of hand. In this case, it was 17 years ahead of itself!

Back in 2000, it seemed like Microsoft was unstoppable and would forever be on every computer. Then LINUX came out, the US Government started an anti-trust case, and Apple started to get more popular as a micro computer.

Then corporations that had approved special budgets for hardware and software to be safe for Y2K, stopped buying and profits dried up and the stock market crashed.

When companies miss their earnings targets, their stocks decline. The darling “4 Horsemen” tanked and so did the rest of the market. It declined over the next 3 years until the bottom in 2002.

Now the information technology index has risen above where it was in 2000.

Tech stock fundamentals look good, but the FANG’s may have gotten ahead of themselves.

The stock market has narrowed considerably to a few stocks - the FAANG’s.

Here is the article. I’ll also post the article on my website.

Here is the article:

How can you tell if stocks are ahead of themselves?

An easy metric is checking the P/E ratio.

Price-to-earnings ratio is price divided by earnings per share.

The average for the entire stock market is about 15 to 17 over the long term.

Certain high growth stocks can get ahead of this.

A P/E of 25 says you’ll pay $25 for $1 of additional earnings.

Right now Amazon has a P/E of about 178. That means you’re paying $178 for each $1 of additional earnings. Does that make sense to you? It seems like bubble territory to me.

2. Are sales and earnings rising?

What are the new products coming? Apple iPhone has a new version coming out. I hear it is going to be $1200. Is that going to generate sales or stagnate them?

Tesla has a less expensive version coming out, but can it sell enough to continue to justify a high stock price over $300 and P/E ratio of -$68.86. It has an EPS loss of -$4.77.

Just to be clear, it’s not profitable yet, but the market has given it a valuation of $54B.
Could that have gotten ahead of itself and priced in gains that won’t be seen for maybe another 17 years? Hmmm.

Are there even earnings at all? On many tech leaders, there aren’t. That makes is a big game of musical chairs because as long as the music keeps going, the stocks keep going up. When the music stops (from whatever cause, internal or external), the price may drop substantially because there is nothing to support it except investors bidding up the price based on future hope.

It should be noted, it does have a huge group of investors who are selling the stock short, betting it will go down. Because you have to borrow the stock and hope to buy it back at a lower price, your losses can be unlimited. Therefore, short sellers are forced to buy back the stock to cover their positions and losses, driving the price higher. It’s convoluted but it is happening!

3. What are competitors doing?

Are there new competitors in the market place?

4. Is there new technology competing with this? Is the market changing?
Is the market growing or declining? Oil vs. solar will be a big change.

5. The main thing I want to stress is profitability. When companies get way ahead of themselves and sell for outrageous valuations, a realignment is coming, the question is only: when?


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