I really don't know what's going on with this market, but more and more I see valuations that simply don't make any sense. Either I'm out of touch with reality or something is radically changing in the way the market is pricing equities.
Salesforce.com (CRM) for example was up almost 8% on Friday because the company reported better than expected Q4 results. For the full fiscal year 2013, the company reported revenue of $3.05 billion, an increase of 35% from the prior year. For the full fiscal year 2013, GAAP net loss per share was ($1.92), and non-GAAP diluted earnings per share was $1.63.
Even if we assume that non-GAAP results are the correct way to value CRM, does this mean this stock has a right to be at $185 with a market cap of $27 billion? According to Mr. Market yes.
So in sympathy to Salesforce's "spectacular" numbers, the whole SaaS space rallied last Friday. NetSuite (N) rallied as did Workday (WDAY) (the greatest bubble of all times) that has continued to rally through today.
My question is, what can investors expect to gain in the long run when buying at such rich valuations?
Whether or not investors will be vindicated in the long term remains to be seen (I think they will not). But just to give an idea of how expensive these stocks are, here are some numbers:
Every time I encounter a stock with a rich valuation, I immediately look at the short interest ratio because I have a lot of respect for short sellers and I assume they know better than me.
But as the charts below testify, the shorts are getting slaughtered in the SaaS space. Obviously while I agree with their strategy, they have been as wrong about this space as have I:
In Workday the shorts are piling up, but none of them so far are in the money. In Salesforce.com, the shorts have capitulated and are starting to wind down and in NetSuite, they are running for cover and have been reduced by 50% over the last several months.
Forget about buying low and selling high, in this market you have to buy at bubble valuations and sell at bubble valuations to the second power.
Now let's compare the SaaS space to Apple (AAPL). Apple today is just about the cheapest stock you can buy, with just about the best margin of safety of any stock out there. And although I have been advocating selling Apple from the $700 mark, I never said it was a short candidate.
To my surprise, the number of shares shorted in Apple is close to its all time high. Very few have decided to cover. In fact, short interests did not begin to decline until December. How low does a stock have to go to be covered in this market? Also, how can someone short a stock with a P/E of lower than ten with $130 billion in cash in the bank? This is irrational.
(click to enlarge)
(All data from Nasdaq)
And the reason I am pointing out Blackberry is because I think this stock is one of the best turnaround stories of the past couple of years. I'm sorry folks, but everything I know about investing says that you don't go shorting a stock that has doubled from its bottom and has a $19 target price from Goldman Sachs.
This is a very strange market. On the one hand you have extremely expensive stocks that refuse to correct, and on the other you have stocks like Apple that are extremely cheap and the market does not give them any respect.
We also see short sellers that follow the book and short extremely expensive stocks getting killed. This is both irrational and illogical.
And the lesson to be learned from all this is that the market is the market and you cannot fight it, as the short sellers in the SaaS space are learning the hard way.
I think that all SaaS stocks in the future will get beaten down by a lot. I don't know when and I don't know by how much. However, one thing I do know is this: while the market can remain irrational longer than we can remain solvent, it cannot remain irrational forever.
So if you are a short seller who has a good record of shorting stocks, keep the SaaS stocks listed above on your screen, because when these stocks begin to fall, they will fall by a lot. And use the short proceeds to go long Apple and BlackBerry, if you want to leverage up. Both stocks will do good when this market comes to its senses once again.
And if you want to venture in the options space, long term out of the money puts are probably also a good idea for the SaaS stocks.