Markets are feeling a bit like the year 2000

I’ve been on radio silence lately. There hasn’t been much to write about although I am noting the ‘vapour equity’ market has seen considerable supply pressure this month.

The peak of the dot-com boom (at least as far as the stock market was concerned) was in February of 2000 when the Nasdaq peaked to 5000 and you had a whole avalanche of initial public offerings, the most notable one was the IPO of Palm (which was owned by 3Com at the time).

After that it went pretty much downhill as valuations were not supported and liquidity was sucked out of the markets. Old-value stocks (a good example being Berkshire, but pretty much any company with genuine profits that had nothing to do with fibre optics, dot-com networking or e-commerce) managed to keep their value, and in many cases some thrived in the ensuing carnage.

Investors in 2000 that kept their portfolio away from the previous high-flyer sectors would have survived to participate in the next run-up (which, in the USA, was anything related to real estate). Indeed, a successful investor across multiple market cycles must know which sectors to avoid at any given time – clearly taking permanent capital losses (anybody invest in Pets.com? EToys? CMGI?) depletes your ability to invest going forward.

We fast forward to today, where technology, software and anything related to Covid (virtual work facilitation, vaccines, etc.) is plummeting.

There is a lot to review, but I will keep things to Canada. There’s a lot more going on in the USA (e.g. anything that ARKK owns, for example). Anyhow, the most prominent casualty is the high-flyer Shopify (SHOP.TO), which used to be the #1 ranking in the TSX index, but no longer! They’re now back to #3 below Royal Bank and Toronto Dominion.

In the span of 2 months, they traded at a peak of CAD$2,200/share and are now down to about CAD$1,100, which is a peak-to-trough of 50%.  Anybody invested in the company since June of 2020 would have lost money. Imagine if you had bought shares of this thing at $1,800 and now a third of your capital has vanished…

Another high-flyer has been Lightspeed POS (LSPD.TO):

The peak-to-trough ratio here has been even more extreme – from $160/share to about $37 today – a 77% drop.

Another highly touted IPO was AbCellera (Nasdaq: ABCL) – a Canadian company that IPOed on the Nasdaq.  They went public at US$20/share and traded as high as US$70 on the day they went public, but since then it has been a decline down to $8.50 today – nearly a 90% peak-to-trough loss.

Looking at some other recent TSX IPOs we have, starting September 2021:

CPLF
PRL
QFOR
DTOL
EINC
CVO

Bringing up the charts of all of them, it’s not a pretty picture. One other notable broken IPO I examined in the past was Farmer’s Edge (TSX: FDGE) and they are down about 85% from their IPO. Another one which I didn’t write about but was an obvious avoid in my books was Eupraxia (TSX: EPRX) which I have to commend the underwriters for vomiting out that firm to unsuspecting retail shareholders.

There’s a few lessons to take home here, but one obvious lesson is that just because something has dropped by 50% or 80% doesn’t mean it is still ‘cheap’.

Many of these high-flyers that make headlines are trading at ultra-premium valuations. Take Shopify – down 50% peak to trough. While the company makes money it is still nowhere near a reasonable multiple of its existing market valuation. An investor is still paying a huge premium for assumed future growth – and the company has to exceed this in order for an investor to get a payout (never mind a dividend!).

Even in the case of companies like Lightspeed that are down 80%, it is very difficult to determine whether an investor will be seeing any returns at the end of the day – they are still losing money in their operations.

Many people got their start in investing during the Covid-19 era. A lot of them caught the right stock at the right time (e.g. Gamestop) and probably started having dreams of trading their way to riches. Without the underpinnings of understanding the fundamentals of companies, inevitably these hordes of retail investors simply traded companies on the perception of sentiment rather than any earnings power. Without having a general idea of an entry and exit point, one could rationalize GME at $100, $200, $300, etc., or Shopify at $1,500, $1,700, etc., and are effectively trading blind. One can also make a similar argument for cryptocurrency markets – functionally a zero sum game.

A good question for these new traders is – do they have the discipline to get out? Or will they try to hold on and “break even”? Or will they average down as these high-flyer shares crash back down to earth? If the 2000-2003 model is similar this time around, there will be a lot of people that will be holding onto ever depreciating shares and the current wave of hype will come to a close.

Keep in mind the simplicity that math offers – if something goes from $100 to $50, there is a 50% decrease in value. If you purchase at $50 and it goes down to $25, the result is the same – a 50% loss (and if you were starting at $100, that’s a 75% loss). In many of these cases the companies’ trajectory will head to zero, and it doesn’t matter what “discount to the 52-week high” you purchase the stock at, you will face losses if/when it heads to zero.

The safety in the markets are in those companies that are producing sustainable cash flows. You will still take a considerable hit if the company in question is trading at a very high multiple. The maximum safety are in those companies trading at low multiples to cash flows and those that are not reliant on renewing excess amounts of debt financing. There isn’t a lot of safety out there, but astute readers on this site have picked up hints here and there as to what offers a degree of safety.