>I think what we are seeing is a "devaluation" of software and networking stocks
>much like the devaluation of the Mexican Peso.
I think we agree that the market is crashing, and consistent with this there is a reduction in what the market is willing, or having, to pay for shares of software companies - for all the kinds of reasons you listed. However, you shouldn't think of this as a devaluation much like the devaluation of the Mexican Peso.
When the Mexican Peso gets devalued, it is undeniably worth less. When the financial market crashes a stock, the value of the stock may or may not have changed.
I'm nit picking over this fine point for an important reason. At times like these, it is important for investors to realize that the issue is not that one day the market will become kinder and bestow them higher valuations, like in more halcyon days. What if it doesn't? What if the stock market has decided to permanently devalue all software companies, reducing all PE ratios by X percent? Worse still, what if the market has just awaken to the realization that Mark Brophy is correct, and price should equate to a small multiple of Book Value. Must the fatalist investor just have to learn to live with these new realities? If so, does this mean that Mark is helping us re-calibrate the value we should be willing to pay for WIND?
The issue is that the current financial market is not the arbiter of value. It cannot choose to henceforth devalue stocks with high PE's or low PE's or anything else. It has no official say about the value of any stock. Like us, it is constantly guessing about future value, expressing these guesses as a willingness to buy the stock at a current stated price. Like us, it makes mistakes. But unlike us, it sometimes spins out of control in so-called manias. In fact, during the resulting manias, it is always wrong. This has been true for hundreds of years. Since software stocks are undeniably (with Mark excepted) suffering a down-side mania, AKA a market crash, why would anyone who can read this thread care what price a looser like the financial market now places on WIND? That is, other than to arbitrage it profitably?
If very high future earnings streams of a class of stocks become credible, then those stocks will carry a high PE ratio whether the financial market likes it or not. Otherwise I can devise an arbitrage position which guarantees a positive risk-free return. You may believe the market may dislike giving stocks high PE ratios, but what it really cannot stand, during normal times, is to give anyone a risk-free return. In particular, if WIND convinces the market of the inevitability of high earnings growth, then like it or not, the financial market must return to normalcy by increasing WIND stock until the earnings stream is discounted in the current price. If this takes the PE ratio to 500, so be it.
The simplest (practical) definition I can devise for the true (intrinsic) value of a high-growth stock is the present value of the market price many years hence. With an infinite time horizon, there are only two things that affect intrinsic value: the future stream of earnings (free cash flow to be exact) and the discount rate. To be practical and deal with a finite time horizon, then there is also a behavioral assumption about the financial market at that future point in time.
If the current financial market's estimate of intrinsic value differs from mine, then we must disagree on some or all of the three items above. By keeping the valuation time horizon to just a few years for practical reasons, then the discount rate cannot be the cause of large discrepancies in valuation - at least in this economic environment. Also, the future behavioral assumption about the stock market can be eliminated as a factor by assuming a lower-bound on the PE ratio extant at that future time - in other words, a worst-case scenario. This leaves the credibility of the stream of future earnings as the only possible source of significant difference between the current market's assessment of intrinsic value and that of the seasoned investor.
If you believe with near-certainty that WIND will grow earnings even roughly like what even Mark estimates (which are sharply less than what I believe), then buy WIND now for a exceptionally high near-risk-free return.
If you believe that WIND is pricey, then you must believe that WIND will be stumbling over their earnings in the next few years. With all the things this marvelous company is up to and discussed on this thread, what could possibly make you think that?
It is illogical to believe that WIND is pricey while also believing that it will continue to grow earnings at a 30+ rate over the next decade.
And just for Mark, please note that Book Value has very little, if anything, to do with this issue. Actually it can for stocks in general, but not significantly in the case of WIND, nor does it when dealing with most software companies with positive net worth.
Allen |
