In his latest presentation, Rich Pzena explains why there’s something wrong with the arithmetic in today’s valuations. Here’s an excerpt from the presentation:
I’m going to start with a little story from 1999. Probably one of the most influential discussions I had as an investor, but to set the stage, we were a fairly young firm. Just in business for a couple of years, and we hit the internet bubble, and for those of you who know what value investing is you know that that’s not a good place to be when everybody’s investing in internet stocks.
We had a period of massively underperforming the markets, and into my office came a woman, a client, who sat down and looked me straight in the eye and started the meeting by saying:
“My grandmother is a better investor than you are. All you have to do is buy Cisco. Everybody in the world has figured this out except for you, and you’re just stubborn.”
I was never phased by that kind of interchange, so I engaged with her and said you know Cisco has a market value of $500 Billion, at the time it was the the most highly valued company in the market, in the world really, and you’re used to making 15% a year, it’s what you’ve been making for the last five years.
So if I was going to buy this whole company and write a check for $500 Billion, to make 15% a year the company would have had to earn $75 Billion per year. They were earning $1 Billion.
So I said don’t you think there’s something wrong with this arithmetic? And she just looked at me and said, “You don’t get it do you!” To which I had to agree. I didn’t get it.
So now I find myself in the same place as I was back then. I really don’t get the arithmetic. It’s really… investing is supposed to be just arithmetic, then it was Cisco today it’s Tesla.
Tesla just became a trillion dollar company. To make 15% a year, if I own the whole company, Tesla would have to earn $150 billion dollars a year. The entire auto industry in the world earns $75 Billion a year. So I’m thinking there’s something wrong with that arithmetic too!
You can watch the entire presentation here:
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Very good observations. The current markets do look a lot like 1999.
The indices could see a major correction because of the weighting of these overpriced stocks.
After the 2000 NASDAQ collapse it took 15 years for the index to recover.
Of course it doesn’t mean that all stocks are trading at silly prices.
There are a lot of very sound companies with good balance sheets, trading at low forward PE’s and that still have considerable upside potential.
I do own Cisco but when I bought it in 2011 for $14.00 the valuation was quite reasonable.