• The chart below shows that the market cap of firms trading at over 20x sales has hit $4.5 trillion
  • We believe this number likely understates the market cap sitting at these obscene multiples due to the massive amount of firms that are still held by private markets
  • Our prior chart of firms trading at over 10x price to sales featured the legendary quote by Sun Micro’s Scott McNealy who stated the 95% decline in stock price was all but inevitable

This chart is another example of the reckless speculation underway today.  Please read on to see how these speculative 20x price-to-sales firms did post the dot.com bubble and how they look today.

Total Market Cap Stocks with P to S greater than 20x

If you are a KCR reader that means you understand the importance of valuation to the investment process.

Paying over 20x price to sales is, in our view, little more than the tacit admission that you are speculating.  At that valuation you are typically betting something amazing is going to happen.

The human tendency to believe we can predict the future is an unfortunate one.  We encourage readers to revisit our Quick Take on what we learned from Chapter 7 of Seth Klarman’s legendary book on margin of safety investing, or read some Warren Buffett or Benjamin Graham’s Intelligent Investor. In our view any source material is better than the media frenzy for the novel, new and cash flow impaired securities so popular among traders today.

The chart below shows the return on stocks at 20x price to sales from the peak in 2000.  You did not lose “some” money.  You lost nearly 90% of your money.

For people who believe in the narratives driving similarly priced stocks to valuations that have no historical precedent for a reasonable return we would like to make the following observation about a 90% drawdown.

One dollar turns into ten cents ($0.10).  It is easy to forget  that if your investment falls to 10 cents you now need a 900% return just to get to the break even point.

20x P to S Return on 1 Invested at the Peak of the Dot Com Bubble

The class of stock promoters endorsing “HODLers” and other acronym rich terms sweeping speculators today might be careful.  As our QTFC on Galbraith’s book about market euphoria reminds us: stock promoters who held themselves out as geniuses became the target of great acrimony after each crash.

The table below compares the companies trading at 20x price to sales today with the crop of companies that were at 20x price to sales at the peak of the Dot.com bubble.  Notice how similar the two groups are. 

Fundamentals of the stocks trading at 20x sales

Today as in 2000 both groups traded at huge multiples of sales, had negative PE ratios, margins and ROAs.  Investors are suffering from a  -10% total yield and being diluted by share issuance.

Ask yourself the following: why is today any different this time than 2000? 

Want to Understand the Future? Build a Bridge to the Past

In 1994 C-Span recorded a presentation by Fidelity legend Peter Lynch.  He was making the case for why investors don’t need Wall Street.  In doing so however, he emphasized the need to understand the companies you own. He talks about how he has made lots of money in firms like Dunkin Donuts and Coca Cola.

A fierce advocate for common sense, Mr. Lynch’s point is to buy what you understand and not treat stocks like “lottery tickets” because there is actually a business behind each share you must understand.

Mr. Lynch contrasts the simplicity and common sense required to make money in the stock market with the type of companies a typical retail investor tends to pursue:

The single most important thing to me in the stock market is to know what you own.  I’m amazed at how many people own stocks they wouldn’t be able to tell you why they own it. … If you can’t explain to a 10 year old in two minutes or less why you own a stock you shouldn’t own it. ….

And this is the type of stock people like to own.  This is the kind of company people adore owning.  This is a relatively simple company. They make a very narrow, easy to understand product: 

They make a 1 MB SRAM CMOS bipolar risk floating point data I/O array processor with an optimizing compiler a 16 dual port memory a double diffused metal oxide semiconductor monolithic logic chip with a plasma matrix vacuum fluorescent display that has a 16 bit dual memory that has a Unix operating system four whetstone megaflops polysilicone emitter a high bandwidth, that’s very important [LAUGHTER],  six gigahertz double metallization communication protocol an asynchronous backward compatibility peripheral BUS architecture four way interleaf memory a token ring interchanging backplane and it does it in 15 nanoseconds of capability.

If you own a piece of crap like that you will never make money.  Somebody will come along with more whetstones or less whetstones, a bigger megaflop or a smaller megaflop.

I made money in Dunkin Donuts.  I could understand it.  When there was recessions I didn’t have to worry about what was happening, I could go there and people were still there.  I didn’t have to worry about Korean imports. 

Mr. Lynch continues:

If you don’t understand it, it doesn’t work. This is the single biggest thing. It bothers me that people are very careful with their money. 

The public when they buy a refrigerator they go to Consumer Reports, they buy a microwave oven they do that. …  They do research.  They go on a trip to Wyoming they get a Mobil travel guide.  … People hear a tip on a bus on some stock and they’ll put half their life savings in it before sunset and they wonder why they lose money in the stock market.  …

I’ll switch my thoughts to my long-shots.  Avoid long-shots. I bought about 30 long shots in my life.  I’ve never broken even on one of them.[1] 

History is clear.  Buying stocks at 20x sales is the act of buying long-shots.  Below is the compound return of investing in stocks over 20x price to sales vs. the broad market.

Return on 1 in 20x P to S and 1 in Broad Market

To the degree you believe the financial history that goes back many centuries will somehow be revoked this time we wish you luck.

Ben Graham Would Not Believe These Stocks:

In this panels below we compare fundamentals of the stocks trading at 20x sales today to the top 25 ranked stocks in our Large Cap and Small & Midcap Model today.  KCR’s research team is convinced that fundamentals will matter again as they always have.

Fundamentals of the stocks trading at 20x sales vs top 25 ranked stocks

The list of stocks over 20x sales today runs into the hundreds.  For the sake of simplicity we only list the firms that are burning cash and issuing stock to fund operations.  Can you explain what these firms do to a 10 year old in two minutes?

Below that list of “value offenders’ we published our top 25 ranked stocks in our Large Cap and Small & Mid Cap models.  Aside from having features associated with quality these companies trade at reasonable valuations.  In today’s environment these groups appear to be a lesson in contrast.  Speculation vs. margin of safety long term investing.

Login or subscribe below to see the list of “value offenders” and top ranked Kailash stocks.

[1] Couple thoughts in this footnote.  First, it took about 50 minutes to transcribe that text as we had to listen to it again and again.  We are sure there are errors in our transcript and for that we are sorry.  Second, in the unlikely event you are reading this Peter, one of the authors on the KCR research team would like to thank you for your patience in his earliest years.  You taught much, asked little and politely tolerated great stupidity.

Disclaimer
The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2020 Kailash Capital, LLC – All rights reserved.