Sun Microsystems Inc: A Lifetime Lesson in Valuation

  • Market cap of firms trading > 10x price to sales is now +$10 trillion
  • Investors who paid 10x P/S to buy Sun Micro lost 95% of their money
  • Summary: Paying 10x P/S for Stocks Can be Hazardous to Investors’ Health

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A Quote from Scott McNealy, Co-founder of Sun Microsystems

‘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?’— Scott McNealy, Business Week, 2002

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We believe that is one of the most famous and important quotes for investors today. If you are interested in finding high quality Midcap firms that make money, pay dividends, and are reasonably priced click here. For those seeking a more extreme example, see our post on the stocks that mark the pinnacle of speculative assets in US history.

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Sun Microsystem’s Market Cap at the Peak Demonstrates the Importance of Valuation

At this moment, the stock market is increasingly dominated by stocks that talk about high-performance cloud computing and data centers. They are often affiliated with or backed by famous and wealthy people and firms in Silicon Valley. We admit to seeing how appealing these stories are.

The Largest Market Cap Stocks are Not Necessarily the Largest Companies

Unfortunately, the quote above is a sharp and unforgiving reminder that a stock with a large market capitalization is not always a large-cap company! That is to say that just because a stock is valued highly on the stock exchanges does not mean the firm’s actual business is big enough to justify the price.

We wrote an entire paper about how the biggest companies in markets today, even the very highest quality ones, face daunting math. With backgrounds in behavioral finance, the KCR research team specializes in identifying market anomalies. That is a very polite way to say that we are in the business of helping you exploit the mistakes that investors have been making for centuries.

Our research on the importance of valuation is extensive. The work ranges from simple to sophisticated. You can find examples of it in numerous pieces like those found here, and in pieces like this one where we explain the fallacy of the Robinhood vs. Buffett “fight.”

For every one of our pieces documenting the dangerous speculation underway we have also published pieces documenting the remarkable opportunities in some of the market’s best companies. As investors chase the latest and greatest hardware and software companies to valuations that provide no margin of safety, they leave behind blue-chip stocks.

This is the essence of the opportunity our work identifies. What to avoid and what to focus on. We believe disciplined and patient investors have tremendous opportunities today. For those interested in reading research on the opportunities in small caps stocks, check out our work The Low Cost of High Quality.

For investors with long-term goals who understand that the easy money being made today cannot go on forever, our work will help save you time and improve your hit rate. We strongly encourage those following a traditional asset allocation model to peruse our paper 60/40 Asset Allocation: Buying a Ticket on the Titanic. As real bond yields have gone negative and nominal yields hover at negligible rates, this piece documents the risks and presents a possible solution.

Our work is not for everyone. And that is particularly true today. If you are looking for hot tips or want to read about who the next Amazon is going to be, there are many services to choose from. We are not here to discourage those that believe people are selling lottery tickets. For those that would like to learn about the actual statistical odds that someone can figure that out, we have an entire series of papers you can read.

The simplest and therefore possibly the most compelling is The Persistence of Profits. History is unforgiving in the verdict it renders. If you’d like to read the report and pose the question to those making such promises, please let us know! KCR is not an adversarial organization, but we do fear that many investors are being hoodwinked by clever promoters.

The promises of quick profits are always alluring. And such promises always seem most compelling after those around you have achieved wealth without work. Unfortunately, these are precisely the moments when bear trading discipline is called for.

We wish all of our subscribers a better fate than those seen by Sun employees who held the firm’s stock from the bubble to the trough. The losses they suffered were devastating. Fortunately, there is a solution. Aside from just avoiding speculative firms, a disciplined program of buying high-quality companies at reasonable prices is a time-tested way to grow wealth. KCR offers many such programs for those interested.

We are currently bringing you FAQs related to some of the more complex terms and ideas as written above…

  1. As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade.  If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you.  KCR also offers a wide range of easy-to-use but sophisticated tools.  Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
  2. Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias.  L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.


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. © 2021 Kailash Capital, LLC – All rights reserved.

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March 5, 2021