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The late, great Ben Graham could've been talking about the recent
rally many years ago when he said, "Wall Street people learn nothing and forget everything."
After a once-in-a-generation three-year bear market that saw the Nasdaq lose roughly 80% of its value, it's completely reasonable to expect the index to rally for a year or so. But to say that we've launched a multiyear bull market in Nasdaq stocks is not reasonable. It would mean that investors learned nothing and forgot everything from the bubble years.
One lesson that investors should've learned after the Nasdaq's bubble burst is that prices mean something. It doesn't matter how much hype and promise tech companies proffer; at the end of the day, the proposition for every investor is still one of value.
There's no such thing as a perfectly priced stock. Every stock, without exception, is either overvalued or undervalued -- some by a little, some by a lot. The prudent investor has a simple question to ask when allocating capital: Does price exceed value? Or does value exceed price?
That's the way I approach the marketplace for publicly traded businesses. To the extent a stock price is significantly lower than the underlying business value, I'm interested in allocating capital to the stock. In the case of the Nasdaq, my calculations of the underlying business value at the top 15 companies in the index indicate that, in each and every case, stock value exceeds business value by a wide margin.
In addition to my conclusion that price is greater than value, here are some additional observations from my review of the top 15 companies in the Nasdaq:
Telecom Stocks Traipse Past Wall Street's Worries
Airline Shares Beat the Odds
Costly Shakeout Still Looms, Energy Watchers Warn
At Dobson, a Death-Defying Rebound
Wondering When Biotech's Happy Hour Will End
Why This Rally Is Different
Wall Street Reinvents Itself
Dynegy, Williams Charge Back From the Brink
- Balance sheets are too strong. Though this is counterintuitive, too many well-financed companies are a negative for investors. A torrent of capital during the bubble years created excess capacity and provided companies with exceptional staying power. In a normal cyclical decline, a natural winnowing process purges weak companies, such as those laden with debt, from the competitive landscape. Instead, excess capital still dominates the scene, even in the face of reduced demand.
As a result, we have more than a few desperate companies flailing about in search of a market. Witness
Apple's (AAPL) - Get Report foray into music,
Gateway's (GTW) sales of LCD television screens and
Corning's (GLW) - Get Report push into the ceramics business for pollution-control devices.
Most leading Nasdaq companies are not shareholder-friendly. I'm not interested in allocating capital to companies that aggressively transfer property from shareholders to employees through excessive stock-option programs. I've written before about
option excess at the top 15 Nasdaq companies.
Free cash flow is low to nonexistent at most leading tech companies. That's especially true when you adjust for share buybacks, which are necessary to prevent dilution from stock options.
Demand for tech is weak. I'd like to see swelling demand in the face of limited supply before I'd get excited about the technology sector, which dominates the Nasdaq index. Instead, I see weak demand coupled with building deflationary pressures, from commoditized hardware platforms, a changing software paradigm (including, for example, open-source programming efforts such as Linux) and fast growth in outsourcing of IT services/programming to India and other countries at a fraction of the domestic cost.
Careful investors should view the huge Nasdaq rally with plenty of skepticism. Historically, bubbles don't burst without assorted severe dislocations that take a number of years to sort through. Ultimately, a winner-take-all resolution is most likely:
have enormous competitive advantages that should facilitate market-share growth and dominance for years to come. (That isn't to be construed as a recommendation to buy the stocks, though.)
So who are the most likely long-term losers? There are too many to name; any company that's not No. 1 or a strong No. 2 in its category is in a perilous position. A few of the obvious candidates include:
- Hewlett-Packard (HPQ) - Get Report: It's a stretch to see much value here. The fat margins generated in printing will soon be under siege by Dell; also, I think the merger with Compaq will eventually be viewed as a disaster, despite the initial earnings bump, largely a result of a slew of accounting charges.
EDS (EDS) : With a weak balance sheet, increasing deflationary pressure, industry overcapacity, a history of poor risk management and a significant competitive disadvantage to leader IBM, it's hard to see EDS being anything more than an also-ran in IT services.
Sun Microsystems (SUNW) - Get Report: I panned this stock when it was trading at $11.88 some 19 months ago. I said it was worth $5 per share -- now that it's trading around $5, it's still a problematic holding for long-term investors. With a strong financial position, it has staying power -- but so does Apple. Sun is quickly becoming an also-ran on its way to becoming an afterthought. It faces a similar conundrum as Apple, too: Recreate yourself or die.
Arne Alsin is the founder and principal of Alsin Capital Management, an Oregon-based investment advisor and portfolio manager of
The Turnaround Fund, a no-load mutual fund. At time of publication, neither Alsin nor ACM held a position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback and invites you to send it to
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