This Day On The Street
Continue to site
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

When Is a Bubble Not a Bubble?

Sector bubbles are more frequent than market-wide bubbles, but still rare. The biotechnology sector experienced a bubble between 2005 and 2006, when the sum of listed biotech companies' market capitalization was about $450 billion (excluding the traditional large pharmaceutical companies that were investing in biotech). Making some assumptions about future margins, one can estimate that these companies would need to earn $600 billion in revenues in 2025 (in 2006 dollars) to justify these prices. To put that into perspective, all the listed pharmaceutical companies combined earned about $600 billion of revenues in 2006.

Company-specific bubbles are hard to find too, and sometimes misnamed. Imagine a sharp share-price drop for a pharmaceutical company that announces its promising new drug has failed in clinical trials. The steep decline doesn't indicate that the price was originally at a bubble level; the original price might have reflected a reasonable estimate of the company's value given a reasonable estimate of the drug's probability for success.

Brinker International (EAT - Get Report), however, is an example of a company that experienced a bubble in the early 1990s. At that time, Brinker, which has 1,700 restaurants (including the Chili's chain) in 27 countries, increased its revenues by more than 20% per year, with improving margins. In 1993, its market capitalization reached $2.1 billion with a P/E ratio of greater than 40 times. But eventually same-store sales began to decline, and the market realized the company's economics were vulnerable. In 1994, Brinker's market cap dropped by 61% to a more reasonable P/E ratio in the high teens.

Although not common, the fact that bubbles do sometimes occur -- that is, prices do sometimes deviate from the fundamentals -- makes it even more important for corporate managers and investors to understand the true, intrinsic value of companies. They may be able to exploit any market deviations if and when they occur, for example, by using shares to pay for acquisitions when those shares are overvalued by the market. But more importantly, they will not make decisions based on what may be the unreasonably high price of their stocks, only to be surprised when those prices return to more normal levels, which they always do.
3 of 3

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Real Money

More than 30 investing pros with skin in the game give you actionable insight and investment ideas.

Product Features:
  • Access to Jim Cramer's daily blog
  • Intraday commentary and news
  • Real-time trading forums
Only $49.95
14-Days Free
14-Days Free
EAT $46.77 -0.64%
AAPL $95.18 1.64%
FB $117.43 -0.96%
GOOG $692.36 -0.84%
TSLA $232.32 -3.92%


Chart of I:DJI
DOW 17,750.91 -140.25 -0.78%
S&P 500 2,063.37 -18.06 -0.87%
NASDAQ 4,763.2240 -54.37 -1.13%

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs