Calculators separate wide-eyed optimists from level-headed investors targeting fair value
Odds are stacked against the likes of Tesla and Nvidia delivering good returns from current prices
Wall Street is one of the few places where customers rush for the exit when prices fall and where they clamber to get into the room as prices climb. Market movements over the past year reinforce this established behaviour, which spans centuries. Dogecoin, bitcoin, CryptoPunks, Shopify, Nvidia and Tesla are on a tear — and buyers keep coming as prices push higher.
Bridgewater’s Ray Dalio comments that cryptocurrencies are “one hell of an invention”. But, he argues, valuing them is highly uncertain, and it is difficult to make sense of bitcoin soaring through $55,000 for a gain of 75% in 2021.
The widely admired Tesla and Nvidia A trade at 23 times sales and Shopify at 60 times sales — valuations that are closer to “wide-eyed optimism” than they are to “level-headed fair value”. Even a cursory study of market history suggests the odds are stacked heavily against these investments delivering good returns from these prices.
And then there are CryptoPunks, changing hands for hundreds of thousands of dollars. Applying every model in Aswath Damodaran’s iconic Investment Valuation it seems impossible to get to $131,874 paid last week for CryptoPunk 8847 with “orange side, purple lipstick and cigarette”. No doubt, for people who are participating in this market the ride is exhilarating — and those who are watching the market soar from the sidelines will seem grumpy and cantankerous. But this activity has far more of the attributes of risky speculation than investment.
The opposite holds on the flipside, where there is a world of opportunity with risk taken off the table because people have rushed for the exit and pushed prices far below fair value. During some of the darkest market movements of 2020 equity markets shed trillions of dollars, commodity prices collapsed — recall the price of oil futures contracts going negative — and emerging market currencies came under pronounced pressure as customers raced for the door.
They may not be as glamorous as cryptocurrencies and cyber dreams, but the German DAX, Prague Stock Exchange and Spanish Ibex trade on an average 10 times through-the-cycle earnings
From market histories that run over centuries — and which include the disruptions caused by revolutionary technologies and the dramas of financial and political crises — the evidence speaks loudly again and again: follow the facts, not the crowd. This point is made succinctly by Seth Klarman, founder and president of the highly successful Baupost Group with his clear-headed observation that investing, at its core, “is the marriage of a contrarian streak and a calculator”.
As Tobias Carlisle, author of The Acquirer’s Multiple emphasises: not for one moment does this mean it is sufficient to be a contrarian. Sometimes — indeed, often — consensus is right and the sensible place to be is with the market, and not against it. However, when armed with a calculator the contrarian has the tools to identify where large gaps emerge between price (what you pay) and value (what you get).
Which is exactly the case with the examples above, including assets owned in emerging market currencies in 2020 — the Indian rupee, Russian rouble, Malaysian ringgit and Brazilian real — which all were pulled by sentiment far away from their fair value of purchasing power parity; or established businesses with strong cash flows that were sold down heavily in spooked markets; and “negative oil” which made for great headlines but made little economic sense and, since the start of this year, has delivered a 200% gain.
Investors will heed Benjamin Graham’s advice: if you have formed conclusions based on facts, and your judgment is sound, this gives you an information edge, and the calculator gives you a margin of safety. Armed with the tools of this contrarian lens and our calculator, there are investments outside the $74m market for CryptoPunks that look attractive.
They may not be as glamorous as cryptocurrencies and cyber dreams, but the German DAX, Prague Stock Exchange and Spanish Ibex trade on an average 10 times through-the-cycle earnings. That’s about two-thirds of the long-term valuation in markets made up of established firms with viable business models, growing cash flows and with an average dividend yield of 4.4%. Sentiment may be against these firms in this environment, but the mood will change, and so will their prices.
More specific cases include emerging market assets that have been ignored, such as SA mid- and small-cap companies backed by skilled capital allocators that trade at deep discounts to fair value, such as Brian Joffe’s Long4Life trading 40% below net asset value; the fintech-rich African Rainbow Capital priced at a third of net value; or PSG Group priced R5.4bn below its R20.9bn sum-of-the-parts. An equivalent example in developed markets is Intel, whose processor technologies help mine cryptocurrencies and build blockchains. Armed with a calculator, its cash flows are worth about $80, some way above the share price of $63.
CryptoPunk 8847 so far is a 10-bagger in 2021. However, in a hyped world with many hard-to-figure valuations, investing is about buying businesses that we can value, that have strong balances sheets, experienced management teams and growing business models — with wide margins of safety to the downside and loads of road to the upside, based on valuation and not sentiment.
• Dr Saville is CEO of Cannon Asset Managers.
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