High on Hope

Is the market full of hot air?

Photo: Davide. Source: Pixabay

Some portions may be. Some shares are so puffed up it doesn’t look like the companies can ever justify their valuations. As an example, take LinkedIn. The professional networking darling went public in 2011 and didn’t look back. The stock’s been on a tear, rising almost 5 times—a 45% annualized return.

But what’s next? The firm is priced at over 100 times this year’s expected earnings, and over 60 times next year’s. Even if they earned a placement fee on every hire in the country, they’d still be overvalued. The last time insiders bought shares—except for exercising options—was in 2011, when the stock was below 100. Lately, all they’ve done is sell.

Source: Bloomberg

Some have called these companies—LinkedIn, Netflix, Salesforce.com—“hopium” stocks. They trade based on the hopes and dreams of their retail investors, and give them a “rush” every time they go up. They generate lots of noise. And investors get the shakes every time their shares swoon. They should be part of an Exchange Traded Fund, with the ticker H-O-P-E.

Valuation matters. When shares are overpriced, the path of least resistance is down. The market may be fairly valued, but that doesn’t mean every value is fair. If you buy something without regard to value—just hoping to sell it later at a higher price—that’s the “Greater Fool Theory.” And if there’s no one left to buy it from you, you’re the greater fool.

Douglas Tengdin, CFA

Charter Trust Company

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