Is David Einhorn Right About a Tech Bubble?
On Wednesday, world-renowned hedge fund manager David Einhorn told CNBC that we are witnessing another tech bubble. He cites several phenomena as evidence, including:
- Irrational valuations
- Irrational enthusiasm on tech stock IPOs
- Short sellers being forced to cover because of losses
Despite all of these points, he does qualify his claim in saying that this tech bubble is just an echo of the last tech bubble. The bubble is limited to only a few stocks and sub-sectors, and the public isn’t involved. Furthermore, he admits that people recognize this as a bubble.
These last points in particular indicate to me that the term “bubble” is being applied incorrectly. If we look back at some examples, such as the tech bubble of the late 1990s and the housing bubble from the mid 2000s, we find that the mass psychology of investors had a lot to do with the bubble. People didn’t believe that there was a bubble. Tech investors didn’t care if the companies that they were investing in had revenues, profits, or dividends.
Home buyers didn’t buy houses simply as places to live, but as investments — they planned on flipping them, and because of this, they bought houses with very little money down. Furthermore, in the housing bubble period, the banks and mortgage companies were just as caught up in the mania as the home buyers: They didn’t care who they lent money to or how much money they lent because so long as the loan’s collateral, the house, was gaining in value, it didn’t matter whether the borrower could repay.
In this market, there is a lot more skepticism. True, there are overvalued stocks, and there are stocks that, until recently, didn’t seem to be able to trade lower. But there is no tech bubble, at least as an isolated phenomenon. However, one could make the case that there is a much bigger bubble: a bubble in stocks and bonds more generally.
While a lot of investors are willing to acknowledge the bond bubble, the stock market bubble is a different story. Investors are generally very bullish on stocks, and yet they are historically very overvalued. Typically, a good time to buy and to own stocks is when they trade with a P/E ratio of 8-12 times earnings, and when they pay dividends of 4-6 percent. Now, the S&P 500 trades at 22 times earnings and it pays a dividend of less than 2 percent. Short stocks in the aggregate are about 50 percent overvalued.
That doesn’t mean that there aren’t good values out there: There are just more stocks that are overvalued than stocks that are undervalued. Einhorn chose to point out those stocks that are incredibly overvalued — stocks trading at 50-100 times earnings. But consider a stock such as Colgate Palmolive (NYSE:CL).
This is a plain old, boring “widows and orphans” stock that generates consistent earnings, pays dividends, and repurchases its own shares. But there has been very little earnings growth — just 10 percent in the past three years. It also trades at 27 times earnings and pays just a 2.2 percent dividend? With the average historical P/E ratio being about 12-14 and with the average historical dividend being about 4.5 percent, this stock is trading at twice the price it should be.
And it gets worse. When stocks correct, they don’t simply trade down to their average historical valuations – they overcorrect. This means that if we were to see a real stock market correction, a stock such as Colgate can trade down by 65 percent or more. Ultimately, Einhorn isn’t wrong about several tech stocks being overvalued, but the term “bubble” applies to the stock market more generally, as investors are making excuses for paying far too much for stocks, such as “There is simply no other place to go.”
Such excuses are utter nonsense, as there are plenty of inexpensive stocks abroad. Russian stocks trade at 5-6 times earnings. Turkish stocks trade at 11 times earnings. Even in the U.S. we can find undervalued stocks, such as ConocoPhillips (NYSE:COP), which trades at 10 times 2014 earnings, or the fertilizer producer CF Industries (NYSE:CF), which trades at 9 times earnings. AT&T (NYSE:T) just released a strong earnings report; it trades at 11 times earnings and pays a 5 percent dividend! Other assets, such as gold and other precious metals, are also undervalued.
Given these points, investors shouldn’t worry so much about bubbles — simply avoid buying overvalued assets and buy undervalued assets. There are plenty of the latter out there.
Disclosure: Ben Kramer-Miller is long CF Industries.