Financial history suggests that the valuations of the stocks of certain high-flying and profit-averse companies remain questionable and a sign of potential future misfortune.
No doubt, some high-flying stocks will continue to create returns for some investors. That begs the questions, which ones, how many, to what degree and for how long?
Huge explosions in stock offerings and inflations in stock values have happened before with railroad, steel, auto, tire, farm implement and computer companies. Allied Chemical, U.S. Steel, Hudson Motor Car, Lionel, Gulf and Western Industries, WorldCom, Global Crossing, Stutz Motor and others were all darlings of the stock market at one time or another. Now we have Facebook, Twitter, Amazon, Yelp, Tesla and many others — some credible and some questionable.
At the height of the dot-com bubble, we explored the question of peaking stock valuations in some of our classes at the University of St. Thomas. We collected some data on our own and then merged it with data from two respected books on the subject: Robert Sobel's book, "The Rise and Fall of the Conglomerate Kings," and "Extraordinary Popular Delusions and the Madness of Crowds," by Charles MacKay.
We then compared the stock prices of the high-flying companies at their peak to the prices of their stocks three years later. The comparison reflected a decline of 93.2 percent.
The pitfalls of irrational exuberance have been evident in recent years. In 2006, Citigroup stock was $545 per share. Three years later, it was $40 — a decline of 93 percent.
Some people say this could no longer happen. Perhaps, but let's look at where we are.
Morgan Stanley's ClientServ database provides market capitalization and many other useful financial ratios for nearly all listed companies. We downloaded data for July 31 on 707 of the larger companies and then supplemented it with other data. I was a little surprised to see the extraordinary valuations of the stocks of companies that do not earn very much or have less favorable financial ratios.
Amazon, for instance, makes little or no profit but had market valuation approximately equal to the combined total of 3M, Target, General Motors and Ford. These four well-established companies have combined annual profits around $20 billion and employ 840,000 people in well-paying jobs. Amazon barely breaks even once in a while and employs 154,000 — mostly in lesser jobs. Yet it is valued higher than all of the nation's publicly traded railroads combined.
But there are other questionable valuations. LinkedIn, Tesla and SalesForce.com, all of which also lose money, are each individually valued higher than such established profitable companies as Paccar, Corning, Macy's, Cummins, Kellogg and Applied Materials — all of which are profitable, pay dividends and employ a great many people. Twitter loses money, but is valued at around $20 billion.
True, social media is a phenomenon. But then, so was the Fisk Tire Co. At this time, LinkedIn, Tesla and SalesForce.com are losing money at the rate of $1.2 billion per year and are still enjoying stratospheric share prices.
The important problem with overly inflated stock values is not only the hardships created when they ultimately reach normal levels but also the opportunity costs.
While we are basking in the pseudo prosperity of speculation, our country is losing its standing in some of the best wealth-creating industries that have made the county prosperous and its military first rate. In the manufacturing of many critical components, such as encoders, bearings, compressors, pumps, ships, motors, valves and electrical equipment, the United States no longer is the leader or, in some cases, not even a major player.
More recently, we have begun to see an erosion in the high-value end products made from these critical components, such as machine tools, aircraft and even medical devices. All this while we value the stocks of some money-losing companies engaged in little of importance at $500 per share.
One may wonder why ordinary citizens would flock to these highly speculative investments. The answer is that they don't; the vast majority of these speculative securities are owned by institutional investors — pension funds and mutual funds, supposedly custodians of the nation's savings. Shouldn't we wonder what is going on here?
If these highly speculative stocks live up to their hype, none of us will be disappointed. But if it turns out that these speculations follow the patterns exhibited in the past, we may wish our fund managers looked more closely at the fundamentals.
In the meantime, we might reflect on the wisdom of allocating so much of the country's investment resources to enterprises that appear similar to bubbles we have experienced in the past. As auto industry historian Arch Brown's father remarked about the high price of Cord Automobile Co. stock of an earlier day, "It makes an interesting speculation but a lousy investment."
The larger question is whether speculation and lousy investments are best for the country.