The onward march of the asset-light business

Of great interest to us are the internal workings of markets. These are often very good indicators of where we are in the ebb and flow of valuation cycles. Valuations work, provided you are patient. They especially work if the constructed relationship is mean reverting and also non-mainstream.

Recently, we have been looking at equity valuation dispersions: that is, the gap between highly valued equities at one end and lowly valued equities at the other. It is unproductive to guess at where the natural relationship lies: it can be plotted and therefore a mean or average level can be observed, but does the average mean anything in this instance?

Of greater interest is when the range relationship becomes distorted due to the radical re-pricing of one group, or a thematically linked group of stocks.




A glance at the above chart indicates that, in recent financial times, this happened most dramatically in the TMT bubble which burst in 2000. In 2000 the ratio of the book multiple of the high price to book value stocks ran up to a multiple of 2x that of low price to book value stocks. Bear in mind, this is a measurement of all listed equities, not the most highly rated, nor is it sector specific. In the TMT boom, a group of telecom and tech companies became so spectacularly overvalued that they pushed the averages.

The most recent plot of this relationship is suggestive that another wave of enthusiasm is engulfing markets and in some of the same places: tech and biotech, two sectors that are very well represented in the NASDAQ index. The cumulative annual rate of outperformance of the NASDAQ compared with global equities has reached.

A simple chart of the world internet index against a world equities index reveals the magnum of outperformance very clearly.


Turning back to our valuation dispersion chart: we note that an upswing is clearly underway. We also note that at a multiple of 1.3x, the relative valuation contortion is nothing compared to the 2000 period. Limited comfort can be drawn from this; the 2000 period measures as a 3.5x standard deviation event. It was the mother of all bubbles, unsurpassed by anything of the past 100 years and comparable only to the Japanese equity market bubble of the late ‘80s and the US residential bubbles of the ‘00s.

Financial commentators have become very sensitive in this area and the tendency to cry bubble has multiplied in recent years. Whereas we would certainly question the valuations on offer in some of the hotter concept areas, it is hard to entirely back the bubble claim.

The growth oriented equity investor is left in an uncomfortable place. In a world where the paths to commercialising intellectual property have become admirably short, we wish to invest in new technologies where human inventiveness is at its best. On the other hand, investors of every stamp know that one of the greatest determinants of value obtained is the price paid.

A cooling would be helpful now, it has just started.

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About the Author:

James is a co-founder of Cerno Capital and lead manages a number of the firm’s collective and private portfolios. After qualifying as a chartered accountant in London (Coopers & Lybrand, 1989) he relocated to Asia. Between 1991 and 2004 he worked as an equity analyst, head of research, and latterly as an equity strategist at WI Carr, Paribas, HSBC and UBS, based variously in Hong Kong, Singapore and Jakarta. James graduated from the University of St Andrews, Scotland with an MA in Philosophy & Logic in 1986. James is a Member of the Chartered Institute for Securities & Investment.