Stocktake: Trading on prospects for the hereafter


Twitter’s stock market valuation is more expensive than any other major market flotation since at least 1975, according to IPO expert Prof Jay Ritter. Even leaving aside the eye-popping $45 price at which shares opened for trading, the $26 IPO share price gave Twitter a market value of $18 billion, or 33 times last year’s revenue. That trumps the infamous Palm IPO of March 2000, when the company was valued at 29 times sales, as well as last year’s Facebook offering (26 times sales).

It’s more than triple Google’s 2004 price/sales ratio (PSR), and aeons away from the S&P 500’s ratio of 1.6.

The 15 IPOs with the highest PSRs went on to lose an average of 5 per cent over their first six months, Ritter notes.

Marketwatch’s Mark Hulbert notes that, between 1996 and 2005, new companies that did IPOs averaged five-year revenue growth of 212 per cent. If Twitter matches that, it will have 2018 revenues of $1.7 billion.

Multiply that by 5.87 (the median PSR of internet companies five years after their IPO), and you get a 2018 valuation of just $9.8 billion – a fraction of current levels.

In other words, a $26 share price well and truly discounts the future, but a $45 one discounts the hereafter.

IPO fever a cause for concern
Long-term investors should be sceptical of Twitter, but not for the reasons advanced by many commentators. “Twitter IPO More Expensive Than Facebook Without Profits”, headlined Bloomberg, noting Twitter is currently losing money, unlike Facebook when it debuted in 2012.

However, it’s not uncommon for tech companies or growth stocks to be losing money at the time of their IPO. Twitter’s $26 IPO price valued it at roughly 11.8 times 2014 sales estimates, almost identical to Facebook’s 11.4 PSR. If anything, Facebook valuation is less defensible, in that the company, like any mature large-cap stock with a $120 billion market capitalisation, has less room to grow.

Similarly, sceptics argue that IPO fever points to a topping market. This year has seen more IPOs than any at any time since 2007, while the average stock has enjoyed a one-day pop of 26 per cent. Six IPOs have more than doubled, the most since 2000.

However, while social media stocks like Facebook and LinkedIn are indeed at nosebleed valuations, the tech sector as a whole is nowhere near the dotcom madness seen in the late 1990s. In 1996, for example, the average one-day pop was almost 70 per cent, while every year between 1991 and 2000 saw first-day returns that exceeded 2013’s. Similarly, all those years saw more IPOs than 2013, so the current environment is much less feverish than the headlines suggest.

Equity allocations hit a high
Equity allocations have hit six-year highs, according to the latest American Association of Individual Investors (AAII) survey.

Stock allocations are at 66.3 per cent, the highest since September 2007, and have now been above their 60 per cent average for nine of the last 10 months. It’s a far cry from March 2009, when equity allocations plunged to just over 40 per cent and cash levels hit record highs.

Ordinary investors, as the above stat indicates, have a justified reputation for buying near tops and selling nears bottoms. Allocations nearly touched 80 per cent in early 2000 before collapsing to just over 40 per cent in mid-2002, at the tail end of a bear market that saw indices halve. Sharp declines also occurred during brief market corrections in 2010 and 2011.

However, the current levels should not be taken as a market-topping signal. Yes, the current timing is bad – the time to be bullish was when markets collapsed in 2009, not when indices are at all-time highs four years into a bull market.

However, allocations hit current levels in late 2003, and the bull market went on for another four years. The recent rise in equity allocations has been gradual, and there is no sign of the irrational exuberance associated with market tops.

Citigroup’s complacency alert
A major top may not be evident but Citigroup bull Tobias Levkovich admits the firm’s widely followed Panic/Euphoria model is “sending a clear warning sign of substantial complacency”.

The contrarian indicator is derived by examining sentiment surveys, short selling data, margin debt, retail money market funds and various other measures. It’s currently just shy of euphoria levels, and is at highest point since May 2008.

Levkovich, who is bullish long term, says one must nevertheless “respect gauges that have proven to be a reliable indicator of nearer-term share price movement”, adding that current readings indicate an 80 per cent probability of a market decline in the next 12 months.

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