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When discussing allegedly expensive US tech stocks, it’s important to take a step back and think about why some equities are priced at double digit multiples of sales.
Say you have $1 now. If you could guarantee that pound coin was to grow at 30 per cent per year for the next four years to a price of $2.85, what would you pay for it now? Well, its purchasing power will probably be a touch less by then due to inflation, so probably the $2.85 minus a discount. Let’s say $2.60 or so.
Easy enough. But here’s where it gets tricky with the pricey stocks. Not only is buying an expensive scrip a bet that this revenue growth will continue at a pace into the future beyond expectations, but that the particular business — whether it’s PayPal, Twitter or Snapchat — will be able to convert those revenues into meaningful profits. Both outcomes are highly uncertain and idiosyncratic to every company, and depend on a multitude of obvious factors such as competition, management quality and the structure of the sector.
For instance, it would be easier to imagine that say Snapchat, valued at nearly seven times revenues, can generate meaningful profits, because its larger competitors, like Facebook, do. For companies like Uber and Tesla on the other hand, well, it seems a bigger leap. But simply writing off a business based on a seemingly ridiculous valuation, when it has an obvious growth runway, is foolish. For instance, at no point in its early history was Amazon a “cheap” stock by anyone’s definition of the term:
Which is why we thought it was worth sharing this chart that landed in our inbox a few hours ago from research shop MoffettNathanson. It shows a bunch of the popular internet stocks today, and how they stack up when you plot them on a chart of their current EV/sales multiple, versus MoffettNathanson’s expectations for their compound revenue growth through to 2025:
It’s a pretty neat chart. On this valuation basis alone, Google, Facebook and Spotify seem fairly priced while PayPal, Twitter and Netflix are on the expensive side. Conversely, Roku, Pintrest and Snapchat are relatively cheap. The problem for investors is discerning which of these companies can both meet and beat these estimates and cement a competitive position to the point they can earn super normal profits.
For the moment, we think its best we leave such questions to the experts, including FT Alphaville readers. Let us know your thoughts below.