Beware of New Paradigm Stocks

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Published November 19, 2013

| Covestor

In a blaze of cosmic, star-spangled glory, a new generation of dotcoms has officially come of age. The latest to reach the stratosphere is Twitter (TWTR) which became a public company in November. Priced at a mere $26 a share, it soared to within a hair of $50 within the first two hours of trading. Sweet nectar indeed for those privileged enough to be allocated shares before the start of trading.

The fact that Twitter—currently valued by the market at over $24 billion as of November 18—is losing money, and will likely continue to lose money, should not give pause to those who believe the sky is the limit for this new incarnation of stargazing dotcoms that conjure up reminiscences past and now forgotten shooting stars like Netscape, Geocities, Lycos, TheGlobe.com, Pets.com and Webvan.

In writing about the dotcom crash, Investopedia—which points out that when the bubble popped, the Nasdaq, home of most of the dotcoms, lost roughly 80% of its value from peak to trough —has this to say:

“Companies underwent a similar phenomenon to the one that gripped seventeenth-century England and America in the early eighties: investors wanted big ideas more than a solid business plan. Buzzwords like networking, new paradigm, information technologies, internet, consumer-driven navigation, tailored web experience, and many more examples of empty double-speak filled the media and investors with a rabid hunger for more.

The IPOs of internet companies emerged with ferocity and frequency, sweeping the nation up in euphoria. Investors were blindly grabbing every new issue without even looking at a business plan to find out, for example, how long the company would take before making a profit, if ever.”

But pay no mind. That was then and this is a very different now. We live in a brave new world today of forever rising stars. The chief astronomer, and wealth- effect heaven-maker, Ben Bernanke, and his soon-to-be successor, Janet Yellen will protect us from the silly and outdated evil of rational pricing.

LinkedIn (LNKD) is another stock that appears firmly on the astral plane. It’s currently valued at around $27 billion as of November 18, and fetches more than $230 a share. This Facebook-for-business trades at a price-to-earnings ratio of around 100 based on analyst estimates for next year’s earnings, and close to a P/E of 1,000 if one wants to contemplate last year’s reported earnings.

SPS Commerce (SPSC) is another stock seemingly detached from this earthly realm. Its shares currently trade at around $73 on a company-estimated full year net income of around five cents a share. At that rate, you’d have to own it for over 1,300 years to get your money back.

One of the curious things about the dotcom bubble at its peak was that a value investor—or anyone with a battery in their calculator—could navigate around the Internet-driven madness of the crowd and not only survive, but prosper.

This was because, as money poured into the pie-in-the-sky stocks, it flowed out of many solid, tangible and profitable businesses leaving them unwanted and undervalued bargains. Today it’s not quite like that. The price of almost everything is elevated due to central bank money printing.

It’s impossible to know exactly when this latest celestial display of exuberance and gravity-defying levitation will end. However, the last time we saw stock market stars align themselves in this heavenly fashion, the aftermath was very painful for those who believed in, and invested in, these types of stocks.

The way to survive then is to stay away from the crowd; to walk alone. When the confident hordes rush to invest in ephemeral and fragile notions of some future profit, seek instead companies that are profitable today, with tangible assets and solid balance sheets.

One day the valuations on these new, new paradigm stocks like LNKD, SPSC, and TWTR will come back down to earth. The stars will fall from the sky.

“When I heard the learn’d astronomer,

When the proofs, the figures, were ranged in columns before me,

When I was shown the charts and diagrams, to add, divide, and measure them,

When I sitting heard the astronomer where he lectured with much applause in the lecture-room,

How soon unaccountable I became tired and sick,

Till rising and gliding out I wander’d off by myself,

In the mystical moist night-air, and from time to time,

Look’d up in perfect silence at the stars.”

  -Walt Whitman 1819-1892

DISCLAIMER: All opinions included in this material are as of November 15, 2013 and are subject to change. The opinions and views expressed herein are of the portfolio manager and may differ from other managers, or the firm as a whole.  All investments involve risk (the amount of which may vary significantly) and investment recommendations will not always be profitable. Past performance is no guarantee of future results.

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