In America there are the FAANG stocks (Facebook, Apple, Amazon, Netflix and Google), here in Oz we have the WAAAX stocks. Are these stocks seriously expensive?
Australia’s Tech Flyers
WiseTech Global Ltd (ASX: WTC), Afterpay Touch Group Ltd (ASX: APT), Altium Limited (ASX: ALU), Appen Ltd (ASX: APX) and Xero Limited (ASX: XRO). It’s our own little group of tech superstars that are destined to take over the world, at least that’s what you’d think given the euphoria that surrounds them.
The fear of missing out can be a powerful motivating force in the sharemarket. However, it’s important for investors to remember that any investment can be a poor one if you pay too much.
In a world with ultra low interest rates and stagnating growth, companies that exhibit supercharged growth are the nirvana for many investors. But whilst you couldn’t argue against the huge potential in any of these companies, it doesn’t follow that you should therefore be willing to buy them at any price.
My Business Proposition
Let’s pretend for a moment that we were business partners. One morning I come to you and tell you I have a great idea for an investment. There is this company that has never made a dollar of profit but it’s growing revenue quickly, has huge upside and we can get in for the bargain basement price of $8 billion. Yes, you heard right, that was billion with a B!
Whilst I’m sure my sales pitch could use some improvement, this is the exact situation Afterpay is currently in. You may have noticed my skepticism dripping from the page, but it’s not because I don’t believe that Afterpay is going to be a great success story – I do – it’s simply because much of the blue sky potential is already factored into the share price.
You Must Factor In The Risks
When running the numbers on any high growth investment, it can be tempting to only see the upside. If that’s all you are seeing, then it can be very easy to justify the most eye watering of valuations. All investments come with risks attached and these need to be factored in to your calculations. The risk of competition, slowing growth, poor execution by management and any number of other risks.
The reality is that right now, Afterpay and Xero have racked up a huge amount in accumulated losses and are yet to turn a profit. The believers will say that share prices are driven not by what has happened but what will happen, and they would be right.
My advice is not that these shares should be avoided, but that one should be careful when estimating profits in distant future years in order to justify today’s valuations. It would seem prudent to allow for the likelihood of significant forecasting errors when performing your valuations. But then again, maybe I’m just old fashioned.
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At the time of publishing, Luke has no financial interest in any companies mentioned.
