“But valuation doesn’t matter anymore.”
You’ve probably heard that statement in some form or fashion over the last year as we’ve witnessed a rolling series of manias in markets like never before.
And indeed it is true – at least in the moment. During a parabolic advance, sentiment and herd behavior easily trump valuation and fundamentals.
But nothing lasts forever. Time is the great equalizer and ultimately the price paid for something tends to matter. We just don’t know when…
Ten years ago Baidu (the largest search engine in China) traded at 42x sales and was loved by all of Wall Street. By comparison, Google (the largest search engine in the U.S.) was trading at 6x sales and the broad market (S&P 500) was trading at 1.2x.
Needless to say, investors were expecting phenomenal growth from Baidu and above-average (but lower) growth from Google.
What actually happened?
Precisely that. Baidu’s revenues grew 813% versus 450% for Google and 42% for the S&P 500.
Did Baidu’s stock show a similar advance?
Not exactly. Over the past 10 years investors in Baidu have actually lost 4% versus a gain of 778% for Google investors.
How is that possible?
Baidu’s high starting valuation (42x Price/Sales “P/S”) and ensuing multiple contraction (3.2x P/S today) were enough to outweigh all of its tremendous fundamental growth.
In September 2014, Alibaba (the largest e-commerce company in China) went public in what was the largest IPO ever (raising $25 billion). Investor demand was sky-high, and Alibaba opened at a valuation of 24x sales. By comparison, Amazon (the largest e-commerce company in the U.S.) was trading at 1.8x sales and the broad market (S&P 500) at 1.7x.
Needless to say, investors were expecting phenomenal growth from Alibaba and above-average (but lower) growth from Amazon.
What actually happened?
Precisely that. Alibaba’s revenues grew 931% versus 392% for Amazon and 21% for the S&P 500.
Did Alibaba’s stock show a similar advance?
Not exactly. Investors in Alibaba at its IPO have earned a 98% return versus 1,010% for Amazon investors.
How is that possible?
Alibaba’s high starting valuation (24x Price/Sales “P/S”) and ensuing multiple contraction (4.8x P/S today) were enough to offset most of its tremendous fundamental growth.
Lesson: the price you pay for something tends to matter. It just doesn’t matter within a set or predictable timeframe. It could matter overnight, take months to matter, or even years. No one knows.
But when investors pay an extraordinarily high price for something (on the lofty expectation that staggering growth rates of the present will continue into the future), that is often a recipe for future disappointment. And by the time that disappointment occurs – by the time valuation matters – it’s too late to do anything about it.
Related Posts:
245x Sales: The Most Highly Valued Large Cap Company in History?
To sign up for our free newsletter, click here.
Disclaimer: All information provided is for educational purposes only and does not constitute investment, legal or tax advice, or an offer to buy or sell any security. For our full disclosures, click here.
