2 + 2 = 7 In the Market

By October 22, 2017 Blog

       Amazon trades at a P/E of 250.  Facebook is 40.  For Air BNB, Tesla and Uber the P/Es are undefined because they don’t have profits yet.  The list goes on for many tech companies.  The high P/Es reflect the rapid expected growth in profits and cash flow as companies like these disrupt the businesses of traditional firms.

       While all this disruption has been going during the recovery from the financial crisis, real economic growth has been sluggish – averaging about 2%.  That is a particularly low rate for an economic recovery.  Nonetheless, the S&P 500 has risen by a factor of about 4 – ignoring dividends!  That increase is not due to tech companies alone.  Prices and valuations have risen pretty much across the board.  As the Economist reports, P/Es of old line industries like hotels, credit cards, consumer proucts and so on are all well above historical averages so the market is expecting meaningful growth there too.  This leads to the question, who does the market expect tech companies to disrupt.  If the overall economic growth remains near 2%, the only way for tech company profits to growth far in excess of that is to take business from old line firms.  But those old line firms are also expected to grow faster than 2%.  It is as if 2 + 2 = 7.  That arithemetic is another reason why I am worried about current market valuations.

One Comment

  • Shiyu says:

    It's worth pointing out that some part of tech's growth need not come from disrupting other companies in a zero-sum game. Facebook certainly has grabbed some users and time-spent from cable TV but it has also grabbed a lot of time-spent in DMV-waiting time and similar situations, which wasn't previously monetizable by any companies. In this light 2+2 and 7 might not be a fair comparison.