Paul, you make some good points.
I agree there are no decent valuation models, but I don't think precision is required. Historically you can account for free cash flows and their value, because in hindsight you have 100% of the data. Looking to the future you have to make assumptions. If you take a range (high/low) of discount rates - base these on historical rates - these largely take into account the economic environment. Then you can estimate a range of growth scenarios.
Within that, now very broad model, you can apply judgements based on experience. For example, in the ERP market I see the following to explain (much of) the current ebullient market for these products:
1. Migration from in-house/older package mainframe systems
2. Migration to open systems
3. Big 6 consultancy encouraging BPR, replacement of ERP systems (these guys make far, far more $ than the s/w provider for doing the implementations)
4. Year 2000, great incentive/excuse/fear to replace older systems rather than fix.
I do see the growth rates falling across SAP, Baan, Oracle and PSFT as, once a big co. has signed up with one vendor, they are unlikely to change those new systems for a long time. I feel that we are roughly at the peak for growth and we will see rates decline soon.
We all know what will happen if the growth rate of any of these vendors drops to 'only' 20% - the stock price will get hammered. And if any post flat earnings, it is a big hammer.
That is my most concise explanation why I have adopted the position I have. I chose PSFT as my 'ERP short' because SAP is market leader and Oracle has most of its revenues in other areas. I could have looked at Baan instead.
Regarding market forces, yes absolutely. But these things could change. It is a bit 'chicken and egg', but what happens if investors see a declining stock market? Will they be so keen to pour money - Raptor you are a long way from unique in borrowing money to invest - into this kind of market?
Perhaps a better approach would be to wait for a slow decline - but that's only visible with hindsight. The upside is when these high growth companies stumble on earnings, it causes a big correction. You only need to drop projected growth by a few points to reduce the value of the company substantially.
Right now on PSFT, it is not good for me. |
