Are we headed for a tech bubble?

The median P/S of companies within FactSet’s Internet Software/Services sector that have revenues over $500m (which includes companies like Google, Facebook, Baidu, Tencent, and Yahoo), is 2.4x. The standard deviation of P/S ratios across this same sample (58 companies) is 5.1. Compare this figure to the standard deviation of P/S ratios in other sectors such as Consumer Services (1.5), Transportation (1.4), and Communications (1.5), and you start to see the difficulty in accurately valuing these businesses

Are we headed for a tech bubble?

By Mark Berry, United Kingdom Global Banking & Brokerage Consulting Manager

It’s going to be very painful for investors.” – Jeremy Grantham, Co-Founder of GMO

What stock market crash do you think that quote refers to? Black Monday? The dotcom crash? The housing crash of 2008? The answer is: the one that is coming next.

The tech bubble is real: The case for

Many investors argue that we are in or are approaching a tech bubble. David Einhorn of Greenlight Capital is one of the most high profile people to raise the alarm bells, stating that while “old” tech companies like Apple are underpriced, several “momentum” stocks cannot come close to justifying their valuations.

Other observers take note of the fanciful valuations being put on companies that have relatively weak fundamentals. Companies like King Digital, WhatsApp, LinkedIn, and even Twitter have achieved valuations that, under any typical fundamental-based analysis, defy all logic. Twitter, for example, has a Price/Sales ratio currently over 30x, while Facebook carries 15.9x. By comparison, Apple’s P/S is 3.3x. LinkedIn’s P/E ratio is 680x; Google’s is 31x.

One of the hallmarks of the dotcom crash was investors abandoning proper fundamental analysis of companies in favor of pursuing growth of user base, and many of the IPOs we see today have the same hallmarks.

How is it that a company that has no revenue and no unique IP in the form of WhatsApp can be worth $19bn? Zynga, the online game-maker, posted a Q1’14 loss of $61m, and it currently trades at less than half of its December 2011 IPO price. So how does King Digital achieve a $6bn valuation on the back of revenues that are almost 80% reliant on Candy Crush? Quora, a question-and-answer website with no revenue, earlier this month took $80m from venture capital investors just to keep it in the bank. The most recent company to hit the headlines is Uber, the car-hire app, which has just accepted investment at a valuation of $17bn. Of course, if Uber achieves everything it hopes, then $17bn could well turn out to be a bargain, but what if it doesn’t?

Aside from this, even outside the tech sector you need only to look at the sheer volume of companies looking to tap the market’s appetite for new equity to see that the tides are rising. In the UK, FactSet shows that there have been 57 new listings on the London markets (Main and AIM) between January 1 and May 31, 2014. The number for the same period last year was 24.

Of these IPOs, 25, or 44%, are currently trading below offer price.

Does this mean we are in a bubble? No, but it does show that investors have reservations about the ability of many of these companies to deliver value. It also means that lower quality businesses are entering the market, with investment banks talking up businesses to an extent that fundamental analysis simply does not support.

In predicting a bubble, another oft-cited factor is the rising price of the NASDAQ. It might be below its 2000 peak of 4698, but not by much. It currently sits at 4333, having risen 136% in five years and 27% in the last 12 months. At the current rate of growth NASDAQ will surpass its previous peak before the end of 2014. The S&P 500 has grown 21% since this time last year.

What bubble? The case against

Market bulls argue that we are not in bubble territory; there is nothing to fear just yet.

According to them, U.S. stocks are actually relatively good value (i.e., the P/E ratios are lower). If we look at the NASDAQ and S&P over the last 15 years or so, we can see that the P/E ratios have, removing the anomalies of the 2000 peak and 2008 crash, been fairly steady. The S&P 500 Information Technology sector currently sits at 16.6x on a last twelve months basis. Its 15-year average, including the peak and crash? 16.8x. The NASDAQ’s current P/E of 20.9 also sits relatively well against its average since 2003 of 19.5. It’s the same story when we look at Price/Sales. So we have some way to go before hitting the fantastical heights of previous eras.

The other key argument that market-defenders lean on is the fact that during in the dotcom crash, there was a hysterical investment attitude from not just institutional investors but “every mom and pop investor and every cabdriver and every shoe-shine boy” (Marc Andreessen, Venture Capitalist). There is none of this at the moment. Appetite is being driven by long periods of low interest rates, forcing investors to seek returns in more risky ventures such as startups and junk debt. Moreover, private equity and venture capital firms who a) have been sitting on piles of cash for years, and b) are desperate to offload long-held portfolio companies into the willing arms of the market contribute both supply and demand. Add to this the phenomenal growth rates of some of these tech companies (in terms of user base and popularity, if not profit), and you have a potent cocktail for investors.

So, are we in a bubble? Is the market on a precipice? A subset of technology firms is exhibiting bubble-like behavior even if the term cannot yet be applied to the wider market. Not all of the firms currently riding the tech wave can succeed; indeed, most won’t in the long term. Firms like Twitter and LinkedIn face a huge challenge trying to elicit payments out of users, many of whom would instantly turn away should they face paying fees. The likes of Uber and AirBnB have different challenges, facing the wrath and pressure of regulatory and political opponents. Some of these hurdles may be too big to jump.

What’s to be done, if anything? Surely it’s better to recognize a bubble BEFORE it reaches the peak, so that we can prevent broader damage to the economy by scaling back practices that exacerbate the problem. Hopefully, this time is different. Hopefully, investors have gotten wiser over the years. Hopefully, England will win the World Cup.

What do you think: are we in a tech bubble?

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 Why SunOpta’s Board Should Vote To Sell The Organic Food Company?

Source: Factset. Click image to enlarge

In our current bull market, companies are beginning to come to terms with the fact that their actual businesses are not growing nearly as fast as their stock prices.  Before too long, investors are going to ask for companies to show up with businesses that justify their stock market valuations.  Just like some companies—such as Microsoft (MSFT), Intel (INTC) and others—are taking advantage of the artificially low interest rates available [in the debt market] before they’re gone, some management teams are beginning to realize that the next best route to enabling growth without breaking a sweat is by utilizing their inflated stock valuations to grow their businesses.

Although companies like MercadoLibre (MELI), Arm Holdings (ARMH) and other overvalued technology companies are mainly utilizing their stock prices to dish out hundreds of millions of dollars in options in lieu of cash salaries to keep talented executives, other companies are making a more business conscience move by using their stock certificates to acquire competition and grow their business into what investors are already paying for.  In the tech world, some great examples would be the multiple acquisitions made by (CRM) and  Although these two particular companies have also enriched their executives with countless stock options, they took a step further than others by realizing that their high stock valuations would serve a bigger purpose if it helped them grow their businesses (via stock based acquisitions), and thereby possibly justify even higher valuations.

At the end of the day, a business is only worth what someone is willing to pay you for it (remember this quote for later).  And if that sum happens to be billions of dollars that you don’t actually need to withdraw from your bank account (i.e. stock), in return for a business that continues to generate sales that do indeed get deposited into the bank account, than who’s better than you?

As we’ve seen in recent weeks, the next sector to undergo some serious consolidation will be the food related businesses.  Just this week, we had Sysco (SYY) purchase US Foods’, while WhiteWave (WWAV) agreed to buy the organic produce company Earthbound Farm.  This leads me to my topic, which is why SunOpta’s (STKL) board should vote to sell their thriving organic food company rather than continue to go it alone.

In addition to what was mentioned previously, another outcome of “stock based buyouts” is that they also tend to be much more favorable to the company being purchased.  Since the management of both the buyers and sellers are aware that stock certificates are the oldest form of “Bitcoin” in history, companies tend to pay a much higher premium than they would ordinarily in a all cash transaction, thereby making it much easier to get shareholder approval.  Everyone wins!

About a year ago I published our thesis on SunOpta (STKL)  and the extraordinary value investors were getting for one of the leading organic food companies in the world.  For those who are not familiar with STKL here are a few bullets:

#1 producer of natural and organic fruit snacks in the U.S

#1 processor of confection sunflower in the world

#1 organic soybean processor in the U.S

#1 producer of oat fiber in the world (for food industry)

#1 processor and packager of organic aseptic soymilk in the U.S

Although STKL ‘s stock recently lost some ground from their 52 week high, the stock is still up significantly from when we published the thesis.  Further, the company has reported record sales in their core organic food business, while the two “hidden ingredients” I discussed in length are still very much in play.

So why should SunOpta CEO, Steve Bromley, and the board move forward with selling the entire company?  The simple answer is that management and, most importantly, shareholders would be much better off for it.  Despite being only a slightly smaller “business” (i.e. revenues) than Hain Celestial (HAIN), and drastically larger than Annie’s (BNNY), STKL is somehow still unknown in the investment world.  This lack of popularity means that STKL trades at such a drastic discount to its peers, that it’s costing shareholders at least $1 billion in additional shareholder value, according to our estimates.  Its even trading at a lower valuation than BNNY despite having a business that’s nearly 10 times larger.  So how do we arrive at this +1 billion dollar number?

Although sellside analysts like to mainly use future EBITDA as their multiple for stock price targets, the fact still remains that “at the end of the day, a business is only worth what someone is willing to pay you for it.”  And by that I mean the “entire business.”  In the organic food industry, it is not a coincidence that the Price/Sales multiple is often the more applicable multiple that the market goes by.   The best examples would be if investors looked at what valuations were paid for entire companies, rather than just some of their shares.  As previously mentioned, the organic food company WhiteWave (WWAV) just bought out private company Earthbound for $600 million, a multiple of 1.20 times their expected sales of $500 million ($600mm/$500mm = 1.2).  Keep in mind that Earthbound Farm is a private company being bought out, which tends to be a discount to the valuations public companies typically receives in a buyout.  Further, if you look at the chart at the top, you’d see that the average public company in the sector is receiving a P/S multiple of 2.01, clearly showing the public over private premium I just mentioned.

But despite the fact that STKL is expected to generated $1.35 billion in sales in the coming year, the lack of investor knowledge of its existence is yielding SunOpta investors a market valuation of a mere $585 million, at the current price of 8.82. This is a P/S multiple of only 0.43, even cheaper than the smaller private company Eastbound.  This is why it makes all the sense in the world for SunOpta management to move forward with putting the company on the block and selling it to the highest bidder.  If STKL gets a valuation like the rest of its public peers (P/S of 2.01), then the valuation would be in the range of $2.7 billion, or approximately $39.59 per share, a staggering 447% premium for current investors.  In fact, even if STKL somehow gets sold for a steal of a price like the recent private Earthbound Farm transaction, at a Price/Sales multiple of 1.20, it would still yield STKL investors a valuation of $1.62 billion, or $23.75 per share, a cool $1 billion in additional shareholder value I mentioned before (268% premium to current price). 

The reality is that anyone who knows the organic food industry would also know that there are very few big players in the industry.  At $1.35 billion in revenues SunOpta is considered one of the largest players, towering over numerous $10 and $20 million revenue companies.  My experience has taught me that this type of unique player is more likely to deserve a premium, rather than a private company discount.  But regardless of which premium STKL gets, and even if one were to choose to use the sellside analyst favorite multiple based on EBITDA, it is management and the board’s fiduciary responsibility to do what is best for shareholders.  Although we are very confident in management’s ability over the long run, with at least $1 billion in shareholder value missing from the current picture, it makes much more sense to just put the company up for sale and get paid today.

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 Highest number of Dow 30 companies reported sales growth in Europe since Q4 2011

Source FactSet Nov 22, 2013

Over the past week, the DJIA closed at a record high value (16009.99), and the final DJIA component (Home Depot) reported earnings for the third quarter. During the third quarter earnings season, some companies in the DJIA specifically commented on the difficult conditions they faced in Europe during the quarter. Other companies, however, stated that conditions had improved in Europe relative to recent quarters. In terms of revenue growth from Europe, what did companies in the DJIA report for numbers for the third quarter? Overall, eleven of the 30 companies in the DJIA provided revenue growth numbers for Europe for the third quarter. Of these eleven companies, eight reported a year-over-year increase in revenues. This marked a significant improvement relative to the previous quarter (3). In fact, this was the highest number of DJIA companies to report sales growth in Europe since Q4 2011 (9).

Of the 486 companies in the S&P 500 that have reported earnings to date for the quarter, 73% have reported earnings above estimates. This percentage is equal to the average of 73% recorded over the past four years. In terms of revenue, 52% of companies have reported sales above estimates. This percentage is below the average of 59% recorded over the past four years. In aggregate, companies are reporting earnings that are 1.7% above the mean EPS estimate. This percentage is also well below the average of +6.5% over the past four years. If this is the final surprise percentage for the quarter, it will mark the lowest surprise percentage since Q4 2008.

The blended earnings growth rate for the S&P 500 overall for Q3 2013 is 3.4% this week, unchanged from last week’s growth rate of 3.4%. Upside earnings surprises reported by Deere & Company and Home Depot were offset by downside earnings surprises reported by Campbell Soup, Target, And J. C. Penney during the week. On September 30, the Q3 earnings growth rate for the index was 2.8%. Eight sectors have seen an increase in earnings growth since the end of the quarter, led by the Information Technology and Materials sectors. Only two sectors have witnessed a decline in earnings growth rates since that date: Financials and Energy.

The blended earnings growth rate for the quarter is 3.4%. Eight of the ten sectors are reporting an earnings increase for the quarter, led by the Consumer Discretionary (9.8%), Materials (9.0%), and Information Technology (8.5%) sectors. On the other hand, the Energy (-8.2%) and Financials (-0.2%) sectors have the lowest earnings growth rates for the quarter. The blended revenue growth rate for the index for Q3 is 2.9%, up from an estimate of 2.7% at the end of the third quarter.

The “peak” weeks of the third quarter earnings season are now finished. During the upcoming week, five S&P 500 companies are scheduled to report earnings for the third quarter.

Read more about the earnings trends of the S&P 500 in this week’s edition of FactSet Earnings Insight. to launch the latest report. 

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 A Tale of Two Europes: The UK economy surges while the rest fall behind

A tale of two Europes: The UK economy surges ahead while the rest of Europe falls behind

By Sara Potter, VP, Markets Analysis  - Nov 20, 2013 - FACTSET
Many global market players were caught off guard earlier this month when the European Central Bank (ECB) cut its main policy interest rate to 0.25% from 0.50%. The move came on the heels of the release of the region’s lowest monthly inflation figures since 2009; in October, prices rose by just 0.7%, well below the ECBs target inflation rate of 2.0% and raising the specter of deflation.

The rate cut had been anticipated by many observers; however, it was the swiftness of the action that caught so many off guard. The quick move appeared to be justified a few days later when the Eurozone third quarter GDP numbers were released: Eurozone GDP grew by just 0.1% from the prior quarter, a significant slowdown from the 0.3% growth seen in the second quarter. Within the disappointing overall number were weak performances by the Eurozone’s two largest economies: German growth dipped from 0.7% to 0.3%, while France’s economy contracted by 0.1% in the third quarter.

The weakness in the French economy is particularly concerning for the region. Earlier this month, the ratings agency, Standard & Poor’s (S&P), downgraded France from AA+ to AA; this downgrade comes less than two years after France lost its coveted AAA rating in January 2012. S&P cited the fact that persistent high unemployment is eroding support for the fiscal and structural policy reforms the economy desperately needs in order to stimulate growth.

In contrast to the persistent economic weakness on the European continent, recent signs of economic strength in the UK have raised speculation that the Bank of England (BOE) will have to raise interest rates sooner than expected. For some time, the BOE has had its hands tied by persistent high inflation accompanied by sluggish economic growth and high unemployment. Last August, the BOE announced that monetary policy would be influenced by the level of unemployment as well as the rate of inflation. In recent months, both indicators have been falling faster than anticipated: the unemployment rate has now fallen to 7.6%, its lowest level in four and a half years, while year-over-year price inflation came in at 2.2% in October, just slightly above the BOE’s target rate of 2.0%.

This has brought the Misery Index, the sum of the inflation rate and unemployment rate, down sharply from where it peaked two years ago. The index still remains high compared to the decade from 1997 to 2007 when most of the developed world was enjoying record low inflation accompanied by low unemployment rates; however, the current index level is well below its 40-year average. This is a positive for UK consumers, whose increased spending has been a bright spot for the economy over the last several quarters.

As a result, UK GDP growth has been solid this year. The economy showed quarter-over-quarter growth of 0.8% in the third quarter, following 0.7% growth in the previous quarter. In fact, the OECD announced this week that based on that quarterly growth rate, the UK is the fastest growing country in the developed world. With the Eurozone’s second and third largest economies, France and Italy, both contracting in the third quarter, the paths of the two Europes continue to diverge.

By Sara Potter, VP, Markets Analysis  - Nov 20, 2013 – FACTSET

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