The acquisition of WhatsApp for $19 billion by Facebook has led to some speculation about the possibility of a new global tech bubble, some 15-16 years after the first Internet bubble. Overall, the global economy is not bubbly even if it's a little over-valued. Despite massive infusions of American QE and easy money from Japan, Eurozone, etc., most diversified indices are trading at close to respective historical average valuations.
But some tech businesses like WhatsApp, Twitter, etc., are trading at very high valuations. There are some key differences between 1999 and 2014 which have improved the prospects of tech businesses. The size of the potential market has grown by a factor of 12x or more. In turn, that implies tech PE ratios, which were bubbly circa 2000, are now sustainable.
Back in 1999-2000, there were roughly 250 million global Net users and most used connections with pathetic speeds by today's standards. Now, there's close to three billion net-surfers, many on fast, mobile broadband. In 1999-2000, only the daring considered online spends. (In many places, like China and India, credit card/debit card penetration was very low in 2000). Any tech business is now looking to exploit a far richer, better-enabled ecosystem in comparison to 1999-2000.
In 2000, there were 35 million personal telephone connections in India, mostly vanilla fixed-line. There are now over 700 million personal subscribers, mostly mobile and many on smartphones. Telecom subscribers span every income group above the poverty line. Similarly, the automobile market sees annual sales of over 15 million new personal vehicles (two-wheeler and four-wheeler combined), up from a fifth of those levels, circa 2000.
It is reasonable to expect a competitive business will maintain growth rates that are at least a little higher than the market's average growth rate. If a market matures and the growth rates flatten, the valuation factors would also eventually drop. We know that this has happened in the First World where telecom and vehicular penetration has peaked.
When there are a lot of potential growth industries, investors can diversify while chasing growth. This makes it likely that companies across different sectors will all receive reasonable valuations because investor interest is spread out. When there are few growth prospects, valuations can get strange. A lot of money ends up targeting few stocks. Those few companies are very over-valued, while the rest are under-valued. The averaged valuations offered by indices masks this situation if it occurs. This sort of divergence may be happening across the world. In the US, Twitter and WhatsApp are valued at triple digits PEs, while much of the S&P 500 (average PE 18) is available for single digit PEs and the tech-oriented Nasdaq 100 is trading at an average PE 22.
In India, the 50-stock Nifty is up about 17 per cent in the last 12 months. But the major contributions have come from just eight stocks - the other 42 stocks have lower returns than 17 per cent. Over 30 stocks have negative returns in the last year. This means there are multiple under-valued stocks and perhaps, a few over-valued ones in the Nifty. In the midcaps and small caps segments, the ratios may be even more skewed.
Any investor who subscribes to the theory of long-term reversion to the mean will focus on the under-valued segments in the hope of turnarounds, sooner or later. A momentum investor will look at the few big gainers and hope that those will continue to maintain uptrends. History suggests that mean reversion is more likely over the long term. Note that erstwhile growth industries like telecom, autos, construction, etc., are struggling at the moment. One could hope for trend reversals there.
In fact, there have been few winners for Indian investors outside export-oriented industries like IT and pharma. IT is not in bubble territory. Pharma may be. The IT Index is trading at PE 23 and the Pharma Index is at PE 48 while the Nifty is at PE 18.
A turnaround in low-valued, under-performing domestic businesses must eventually occur. It will be driven by prospects of better macro-economic growth whenever that becomes visible. Looking for potentially under-valued stocks may be a better option than chasing expensive pharma stocks.
But some tech businesses like WhatsApp, Twitter, etc., are trading at very high valuations. There are some key differences between 1999 and 2014 which have improved the prospects of tech businesses. The size of the potential market has grown by a factor of 12x or more. In turn, that implies tech PE ratios, which were bubbly circa 2000, are now sustainable.
Back in 1999-2000, there were roughly 250 million global Net users and most used connections with pathetic speeds by today's standards. Now, there's close to three billion net-surfers, many on fast, mobile broadband. In 1999-2000, only the daring considered online spends. (In many places, like China and India, credit card/debit card penetration was very low in 2000). Any tech business is now looking to exploit a far richer, better-enabled ecosystem in comparison to 1999-2000.
More From This Section
Similar logic applies when valuing businesses in any fast-growing market. If a market has grown massively in size, the historical valuations are no longer good benchmarks. India has seen this sort of growth in telecom services, and automobiles in the last 10-15 years. To a lesser extent, it's also happened in civil aviation.
In 2000, there were 35 million personal telephone connections in India, mostly vanilla fixed-line. There are now over 700 million personal subscribers, mostly mobile and many on smartphones. Telecom subscribers span every income group above the poverty line. Similarly, the automobile market sees annual sales of over 15 million new personal vehicles (two-wheeler and four-wheeler combined), up from a fifth of those levels, circa 2000.
It is reasonable to expect a competitive business will maintain growth rates that are at least a little higher than the market's average growth rate. If a market matures and the growth rates flatten, the valuation factors would also eventually drop. We know that this has happened in the First World where telecom and vehicular penetration has peaked.
When there are a lot of potential growth industries, investors can diversify while chasing growth. This makes it likely that companies across different sectors will all receive reasonable valuations because investor interest is spread out. When there are few growth prospects, valuations can get strange. A lot of money ends up targeting few stocks. Those few companies are very over-valued, while the rest are under-valued. The averaged valuations offered by indices masks this situation if it occurs. This sort of divergence may be happening across the world. In the US, Twitter and WhatsApp are valued at triple digits PEs, while much of the S&P 500 (average PE 18) is available for single digit PEs and the tech-oriented Nasdaq 100 is trading at an average PE 22.
In India, the 50-stock Nifty is up about 17 per cent in the last 12 months. But the major contributions have come from just eight stocks - the other 42 stocks have lower returns than 17 per cent. Over 30 stocks have negative returns in the last year. This means there are multiple under-valued stocks and perhaps, a few over-valued ones in the Nifty. In the midcaps and small caps segments, the ratios may be even more skewed.
Any investor who subscribes to the theory of long-term reversion to the mean will focus on the under-valued segments in the hope of turnarounds, sooner or later. A momentum investor will look at the few big gainers and hope that those will continue to maintain uptrends. History suggests that mean reversion is more likely over the long term. Note that erstwhile growth industries like telecom, autos, construction, etc., are struggling at the moment. One could hope for trend reversals there.
In fact, there have been few winners for Indian investors outside export-oriented industries like IT and pharma. IT is not in bubble territory. Pharma may be. The IT Index is trading at PE 23 and the Pharma Index is at PE 48 while the Nifty is at PE 18.
A turnaround in low-valued, under-performing domestic businesses must eventually occur. It will be driven by prospects of better macro-economic growth whenever that becomes visible. Looking for potentially under-valued stocks may be a better option than chasing expensive pharma stocks.