"I'm riding high...and who can deny; That whatever goes up must fall." — from "I'm Building Up to An Awful Letdown" as performed by Fred Astaire
Investors with a sense of history are carefully observing a trend that last reared its head about 18 years ago and resulted in serious consequences for many.
The last time cyclically-adjusted valuations of companies were as high as they are now was just before the dot-com bubble in the year 2000. As we all remember, that bubble was driven by tech companies that went public in advance of achieving actual profitability. In other words, people were hungry to invest in companies that appeared to have limitless potential, but had yet to prove that they could become profitable enterprises. So the investment was actually in a company's possible future, not in its proven performance. I remember so well that period of time in the late '90s, when any investor could and often did (for a time) make money by throwing a dart at exciting new tech stocks.
The heavy thud of that tech bubble crashing to the ground in 2000 can still be heard by investors with a long memory. In that year, some 400 Russell 3000 companies were trading at 10 times revenues or more. To put this in perspective, if a company earns a third of what it sells, it would take an investor who pays 10 times revenue three decades to earn his money back. Now, some 340 Russell 3000 companies are trading at 10 times revenues or above. We're not back to 2000 levels, but we're getting close.
In addition, some 83 percent of the companies going public today lost money in their last fiscal year. So investors are currently plowing money into businesses that may have cash flow, but have not proven to be profitable or sustainable in the long term. According to University of Florida IPO expert David Ritter, this percentage of non-profitable IPO's is a record.
Ritter was recently quoted in a Wall Street Journal article stating that “(analysts) see similarities with the dot-com bubble of nearly two decades ago that left many investors with enormous losses. The prior high-water mark for money-losing companies going public was 2000, when 81 percent of stock-market debutantes were unprofitable ..."
Stock prices of these tech companies often rose significantly during the dot-com boom after the initial public offering, and represented an opportunity for investors to garner what seemed like an easy dollar. Call it IPO fever. Unfortunately, it's like a game of musical chairs: you don't want to be the investor standing alone without a place to sit when the market determines that these stock valuations are no longer accurate and the bubble bursts.
Margaret R. McDowell, ChFC, AIF, author of the syndicated economic column "Arbor Outlook," is the founder of Arbor Wealth Management, LLC, (850-608-6121 — www.arborwealth.net), a “fee-only” registered investment advisory firm located near Sandestin.