Saturday, September 26, 2015

High Multiple Stocks Carry Major Risk

On occasion silly thoughts occur to most people. My silly thought, or maybe I should call it a question, is whether the people invested in high risk, sky-high multiple stocks of one-man shows like Amazon and Tesla consider the risk they are taking every night when they go to bed. In the case of both these stocks it could be argued that much of the perceived value of stocks like these are derived from the their association with just one man. Occasionally we see how quickly bad news can create a fiasco and destroy value, these events should be taken as a red flag and a reminder of our vulnerabilities. High multiple stocks pose a risk far grater than most investors think and when a company is focused around one man the risk is concentrated. We can only speculate what would happen to the value of one of these high-flyers if suddenly the link between company and its leader were broken through death or an accident.

Chart 2003-2014 Shows Massive Inventory Problem
Currently the market is showing how a rock solid auto company with good profits can be devastated when the unexpected occurs. The thrashing Volkswagen stock has taken after investors were blindsided by news its cars sidestepped pollution standards should be taken as more proof of the risk inherent in paper assets.

In the example of Volkswagen it may be unrealistic to expect anything other than a dead-cat bounce. It does not take a great imagination to see the problems before the company are of biblical proportions. A huge inventory of cars that can't be sold or must be moved at fire-sale pricing is only one of the problems they face. Governments across the world levying fines and seeking criminal charges also rank high on their list of woes even before we consider lost standing and diminished faith of their product. Possibly the biggest problem Volkswagen is about to face in massive claims from current owners of their cars who mount a class action lawsuit asking to be compensated for many things related to this debacle.

Returning to the subject of high multiple stocks imagine a situation where a high flyer is suddenly hit by the unexpected. Often other than a loyal cult following or a stock chart based on momentum the company may have very little to support its valuation. In the case of Tesla you can love the stock all you want, but the obvious elephant is that Tesla stock is trading at incredibly high multiples. Much of this can be contributed to the historically low interest rates and the luck of being in the "QE moment" and not the company's financial success. Ironically it is the bears and those that doubted if the company could hold together that have pushed up the stock as they have been forced to run for cover adding to the image that Musk lives a charmed life. Remember this is a field where many have failed and Tesla is a cash burning machine.  Today the stock of Tesla Motors has a market cap of 32.66 billion dollars, by comparison Ford a major auto maker with real profits has a market cap of 54.16 billion.

Like Tesla Motors the stock of Amazon defies logic,  Amazon is a self promoting hype machine that is far from transparent and has been propelled forward by an environment of cheap and easy money. Add to this blowing shorts out of the market and momentum trading and you have a bubble that could burst at any time. Amazon continues to buy companies, the revenues from these companies add to their growth but mask a key weakness at their core, no real profits.  This has only worked because the myth of future profits around the corner has been dangled before investors like a carrot. If Amazon is a distribution company their stock should be trading at around 18 times earnings. When you look for a P/E ratio on Amazon you find NA because the company makes no money. Another thing we must remember is that new competition can cheaply and easily replicate the most profitable parts of Amazon and cherry pick much of their future potential.

One thing that really bothers me about society today is the lack of balance. If you rated people on a "wealth chart" by how many tangible assets they owned you might be shocked to find much of the wealth people own is in paper and this is full of risk. This means if a person is playing the markets on borrowed money leveraged on top of that by using a margin account they are in a precarious position. This becomes far more dangerous when involved with high multiple stocks. A sudden downfall or rout in value can quickly become a "free-fall." In such a market where everyone is selling and no buyers step up a person may find they are "kaput" before they can place an order to stop the bleeding. High-flyer, high multiple stocks are a disaster waiting to happen. Yes, it may sometime be called a game, but if you choose to use such terminology remember it is a deadly game where you can be utterly finished, defeated, or destroyed and after it's gone you can't get it back.

Footnote; Thanks for reading and please note your comments are welcome. In the archives you may find other articles of interest, below are two post related to the piece above.

1 comment:

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