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The greatest bubble of our lifetimes peaked 25 years ago today. With the Nasdaq Composite dipping into a correction Friday, tech stocks’ recent struggles have many wondering whether history is rhyming. Sadly, the calendar provides no magical warning.
There are signs to be cautious, though, according to Wall Street wise man Howard Marks, whose own timing back then was pretty good. Bubbles, Marks wrote recently, are marked by “highly irrational exuberance,” fear of missing out and a belief that the companies at the forefront can do no wrong so no price is too high for them.
He could add another: When respected figures see danger and are promptly ignored. Marks wouldn’t have to include himself. In December 1996 Fed Chair Alan Greenspan, aka “ Maestro,” used the words “irrational exuberance” to describe tech stocks’ rapid rise. They tumbled for just a few hours. Nasdaq would go from 1,300 then to above 5,000 at the peak. Yet six years after Greenspan’s speech you would have done better just leaving your money in the bank.
Wouldn’t it be great if there were some way to quantify exuberance? At market extremes there can be. Speaking in 2002, Sun Microsystems CEO Scott McNealy was brutally honest about how dumb it was for investors to buy his company’s stock at the peak:
Two years ago we were selling at 10 times revenues when we were at $64. 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? And Sun was cheap compared with Cisco Systems, which fetched as much as 38 times sales and briefly became the world’s most valuable company. There have been many comparisons with Nvidia, which recently won and lost that crown. The AI chipmaker fetched as much as 56 times sales last year. In January it lost more market value in one day than Cisco was worth at its peak.
McNealy’s take is forehead-slappingly obvious in hindsight, but don’t buy or sell stocks on that measure alone. Outside of semiconductors, a sector inflated by Nvidia, one of the highest sales multiples back in January could be found in out-of-favor biotechnology companies. Many have little to no revenue but lots of promise.
At the other end of the spectrum are food retailers, which typically trade around one-third times sales. As much as people complain about grocery prices, supermarkets earn paltry profit margins.
A company that’s very profitable like Nvidia can still look reasonable on a price-to-earnings multiple. “Look” is the key word since it’s been in business for decades and its operating margin has quadrupled recently—a hard thing to sustain, as Cisco and Sun both learned.
Even simpler numbers might have given us pause. Two months ago Nvidia was worth as much as the entire German and French stock markets combined and twice as much as all U.S. energy stocks.
What were we thinking?
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