In the latest AI-driven chapter of mania, chipmaker Nvidia has leapt 186% year to date and is trading about 15% above its November 2021 top. At less than $50 billion in expected 2023 revenue and a current market cap of $1 trillion, the stock is trading about 44x expected sales. Pure madness. There’s no math being done here. Former Sun Microsystems CEO Scott McNealy famously explained the irrationality of a stock trading 10x earnings to Bloomberg in 2002 (after the stock market had crashed) as follows:
At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?”
Now realize that many tech companies are today trading over 10 x their sales, and Nvidia is trading 44x. Let that sink in a bit.
As the 2000 tech bust reminded us, the wilder the valuation overshoots, the harder the fall after that. Nvidia collapsed 90% after its 2000 top and spent 15 years trying to make back losses.
The tech rebound has pulled the tech-heavy Nasdaq and S&P 500 higher year to date, with the S&P 500 now 27% concentrated in tech companies (compared with 33% at the cycle top in 2000). This overweight makes broader markets (which most funds and managers try to track) more vulnerable to losses as excesses correct once more.
Meanwhile, the more economically reflective Dow 30, Russell 2000 and S&P 600 indices remain negative year to date and profoundly negative from their 2021 cycle top. Canada’s TSX remains at about -10% from March 2022. The ongoing bear market for most stocks coincides with recessionary warnings from the Index of leading economic indicators (LEI), which has been contracting for 13 months.
Word to the wise: stocks have never bottomed historically before a recession is recognized and the US Fed has been cutting interest rates for many months. They have not even confirmed a pause yet.
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