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This was on the Prudent Bear chat list. No idea where the original came
from but is well worth considering...
JW
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Moron Alert!!!!(The whole country)
Posted By: Mic
Date: Tuesday, 3/7/0, at 1:36 p.m.
If this article does not explain the madness nothing does. I think the
answer is that we are a nation of superficial, low IQ, greedy and
overall a people no smarter than anyother civilaization who went to
hell.Are stock prices presuming too much growth?
By Timothy Vick, Contributor
Monday, February 28, 2000 2:59 PM ET
No one can ever say for sure what a company is really worth on paper.
Fifty different analysts, each studying the same data, could come up
with 50 different valuations for a stock. Theoretically, their estimates
should be reasonably close, but that rarely happens.
Textbooks tell us that a company cannot be worth more than what
investors can take out of it in earnings. In other words, if a company
is expected to earn a sum total of $10 billion in profits from here to
eternity, after adjusting for inflation and risk, shareholders should be
willing to pay $10 billion today to own all the stock.
So, if Amazon.com’s stock sells for $26 billion in the marketplace,
investors are making the bet that the present value of Amazon’s future
earnings will be $26 billion.
The question is whether $26 billion is a reasonable number, or whether
it grossly inflates the company’s true potential.
Last year, I helped devise a valuation template that Intuit uses on its
popular website, www.quicken.com. The template, called Stock Evaluator,
spits out a hypothetical value of a company based on growth rate
assumptions users can plug in when they visit the site.
Stock Evaluator is a quick-and-dirty means for finding out the maximum
you should be willing to pay for a company given the current level of
interest rates, the company past and future growth rates, and your
rate-of-return criteria.
When I revisited Stock Evaluator a few days ago, I decided to spot-check
valuations for some of the today’s more popular large-cap stocks. But,
knowing how difficult it is to estimate a company’s growth rate, I took
an indirect approach. I started with today’s stock price and calculated
the long-term growth rates necessary to justify that price.
In other words, rather than question whether a stock was worth, say,
$100 per share, I wanted to determine what growth rate was necessary to
make the company worth $100.
A few companies passed the screen richly, indicating that they were
worth at least the current value of their stock. Beleaguered tobacco
maker Philip Morris, for example, would have to exhibit a meager 3
percent growth rate in earnings perpetually to justify its current
washed-out $21 share price. Philip Morris peaked at almost $57 in late
1998.
Abbott Laboratories, the pharmaceutical and medical products company,
would have to grow at 7 percent annual rates to justify a recent price
of $31. Over the past 35 years, Abbott’s earnings have grown at nearly
twice that rate. J.C. Penney would have to grow at modest 6 percent
annual rates to justify its current $19 share price.
But these stocks were the exception rather than the norm. Prices for
many of today’s institutional favorites assume growth rates beyond
belief. The most grossly overvalued popular stock may be Qualcomm, the
telecommunications equipment company whose stock rallied last year from
$20 to $800 before splitting 4-for-1. After peaking at years’ end,
Qualcomm lost about 45 percent of its value in January, settling
recently at a split-adjusted price of $130.
Is Qualcomm a better value now that it is descended? Not hardly. Backing
its way into the calculations, Stock Evaluator found that Qualcomm would
have to exhibit a 44 percent annual growth rate—perpetually—in order to
justify today’s $130 stock price.
If memories from biology class serve me right, not even paramecia
multiply at that rate. If Qualcomm’s sales grew at that rate for just 20
years, and U.S. output kept growing at 3 percent annual rates, the
company would eventually be one-third the size of the economy.
Apparently, today’s buyers of the stock think this is possible.
Cisco Systems and America Online yielded the same discouraging results.
Each would have to grow their net income at 34 percent annual
rates—perpetually—to make the stocks worth today’s trading price.
At that growth rate, Cisco would be one-quarter the size of the U.S.
economy in 20 years, presuming the economy grows at 3 percent rates.
America Online would be one-tenth the size of the economy. Oracle would
have to grow its earnings at 40 percent annual rates; Walt Disney, at 21
percent rates.
Extended bull markets, you see, tend to douse logic. Price and value
become irrelevant and investors increasingly chase “momentum” thinking
that everything must continue to rally at rates beyond reason.
Put these numbers in perspective. If the growth rates uncovered by Stock
Evaluator were correct, the U.S. economy will one day consist of just a
handful of companies, with Cisco, Qualcomm and America Online consuming
68 percent of U.S. output. Throw in Microsoft, Oracle, and Intel for
good measure, and there would be no need, I guess, for any other
employer to exist. We could all work for one of six technology
companies.
If you believe that, buy these stocks at today’s prices.
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