Here we are in the midst of a powerful rally. What does it all mean? Should you be jumping on board, or jumping ship? For the market to embark on a long, sustained rally, there needs to be a group of fast-growing, estimate-beating stocks leading the way to take us there.
In the '90s, it was tech's four horsemen:
. These companies rode growth of personal computing to great heights.
Today, everyone is talking mega-cap and old tech. I don't see a group of leadership companies to sustain this rally. There are great companies out there, but the market's narrow focus remains on familiar names that are already too expensive to provide great long-term growth.
In my prior life, when I built some spec homes, one rule was don't pioneer. Meaning, don't build expecting to get a sale price never achieved in an area before. The same applies to stocks. Don't buy stocks at valuations unprecedented in the group or overall market. I believe that world economic prospects do justify higher stock prices, but asset managers aren't smart enough to look for the new leaders we need to create a sustainable rally.
Let's look at leaders from three different sectors:
to illustrate my point.
Biotech Is Still Pharma
Genentech is an awesome company, one of the first truly successful biotechs and in a battle with
for title of largest. Here is my question for Genentech bulls; put aside your pom-poms and tell me with some tangible empirical support, how is this company worth more than $90 billion?
I know facts are no fun, but to buy this stock here, you are pioneering. There isn't a single historical example of a pharmaceutical company of this size that trades with Genentech's multiples. So an endorsement of Genentech says I know this company can one day soon do at least $30 billion in revenue to justify today's price.
This isn't that complicated; let's have a look at some comparisons.
is the biggest pharmaceutical in the world with a market cap of $200 billion, revenue of $47 billion and a yield of 3.5%.
has a market cap of $133 billion on revenue of close to $40 billion and a yield of 1.6%. Stodgy old
has a market valuation of $48 billion on revenue of $18 billion and a yield above 4%. Genentech's market cap is $87 billion on revenue of $9 billion and no dividend. Huh? When I buy a stock, I want a reasonable risk/return ratio.
Source: Steve Bulwa
My interpretation of this is if everything goes right, Genentech is the next Pfizer and the stock is a double. If a lot goes right, it is the next Bristol and gets cut in half. Insiders aren't buying at these prices either. My finger was getting tired while scrolling back through insider activity looking for an open market purchase. With so many under-appreciated opportunities, why would anyone put their hard-earned money behind this idea? Unless it wasn't
You can overpay for companies, many of the best stocks never trade at a market multiple. You
wildly overpay for big companies: $90 billion companies are already the exception, $90 billion companies that trade at nine times revenue are a big red flag, especially if the industry multiple is closer to three times. That is quite the leap of faith, and for what? Unless you are a large-cap-growth fund manager mandated to buy bloated overpriced companies, I would stay away.
, like Genentech in drugs, has reinvented retail in the minds of many. It is another great company that has executed well for many years, but now the stock has outgrown its market opportunity. I tried to find a retail stock of its size that could support the valuation, but I couldn't.
Coach has a market capitalization of $13.3 billion on 2007 revenue of $2.54 billion for a nifty five times revenue. That is downright unprecedented. In a fad-dominated industry, I don't think you should find comfort paying unprecedented multiples for large-cap growth. I believe more in reversion to the mean than continued out performance.
Most of the companies in this industry trade between one and two times revenue.
has a market cap of $7.2 billion on $4 billion in revenue and
has a $16.5 billion valuation on revenue of $16 billion.
, the highly diversified European luxury retailer, has a market valuation of 40 billion euro on revenue of roughly 15 billion euro for less than three times revenue.
We have run into a similar valuation situation with Coach. Can the company continue to grow and maintain above-industry-average margins or will its performance revert to the mean or worse in this fickle industry? I wouldn't pioneer and pay five times revenue for this company. I would rather buy LVMH, which has a more diversified product offering and a better valuation. No leap of faith here, either.
There is something disheartening about going for dim sum in Toronto's Chinatown and seeing a Starbucks on the ground floor of the building that houses the authentic Chinese restaurant you have been visiting for 20-plus years. I am no purest, but when I lived in California, the dearth of anything culturally authentic was mind-numbingly boring. So I am hopeful Toronto will be able to preserve its numerous independent bars and restaurants, and I am happy to report I never see too many patrons in that Starbucks.
Starbucks stock has had a big resurgence in this rally. The restaurants are back! Right? I guess you can guess the punch line, another star of yesteryear with a ridiculous and unprecedented valuation. Starbucks has a $29 billion market valuation on 2007 revenue of $9.5 billion and a Venti sized P/E of 40. I was looking through the restaurant stocks and I believe the whole group looks overpriced.
trades at one times revenue but 18 times earnings on midsingle-digit revenue growth.
I can't find a food business that trades anywhere near three times revenue like SBUX. It isn't like the stock is cheap from some other standpoint, it trades at 40 times earnings. This stock is going up because fund managers are taking it up but from a historical standpoint, it is unsustainable.
This isn't the real deal. If you throw Cisco, Microsoft and the semi-cap equipment suppliers in the mix, and this rally is a head fake or
Ground Hog Day II
without anyone as funny as Bill Murray or as attractive as Andie MacDowell. Maybe this is the false breakout that finally shakes the foundations of the remnants of the bubble significantly enough to inspire some real change and new leadership from companies that can lead a sustainable rally. Not these retreads that need everything to go right to sustain today's prices.
At the time of publication, Bulwa was short SBUX and COH (and would be short DNA but was too scared of a reaction to any positive FDA announcements) although holdings can change at any time.
Steven Bulwa is an independent portfolio manager based in Toronto. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Bulwa appreciates your feedback;
to send him an email.