First let me preface this by saying that PE ratio is not the end all be all of valuation methods. But it's the "common man's" way of looking at things, even with the caveat that there are multiple ways to slice "earnings."
The more important take away is that we are now seeing the same behavior we saw in 1999, at least with companies that actually had earnings back then. I called it the relative comparison valuation. This is when analysts can no longer find valid reasons to justify prices, so to upgrade a stock they use the "it's not as expensive as company ABC" methodology. This is a lot like how we pay CEOs nowadays.... "well, if Chuck at company XZY is earning $X than I should be paid $X+10." And so on and so forth; you can go on forever, in a permanent spiral upward. Unlike CEO compensation where there is no market force to keep this nonsense in check (boards of directors are just rubber stamps in American corporatism), the market eventually washes out this "valuation method" in stocks. Key word... eventually.
Last week, one of our old stocks Mercadolibre (MELI) was upgraded and I eagerly went to see the reasoning behind it. Our 1999 reasoning was here: "it's one of the top 5 stories out there in internet land!" (Hey, I happen to agree with that idea, but that does not mean you should slap any old valuation on it.) The real reasoning said analyst should have used is: "it's cheaper than Baidu! (BIDU)" Then, when MELI passed BIDU in valuation the BIDU analysts can come out and upgrade Baidu with the reasoning that, "it's cheaper than MELI." And so the two bands of analysts can go at each other, ever increasing valuations on the idea that "it's cheaper than the other guy and a top franchise to boot!" as Greenspan morphs into Bernanke, and we repeat the same reindeer games. Heck, we don't have to even wait a generation or two any more to revisit old lessons forgotten. Thanks, Bubble Makers in Chief.
The only difference (thus far) is that, in 1999, a stock's price would have jumped from $50 to $70 in the opening 15 minutes of the session when it was upgraded. And then the next analyst could have come out with his $90 target within days. This means we are not yet at the Code Red point for bubble making... still at Orange. (Click to enlarge)
Via Barron's. (My comments in parenthesis)
- Thomas Weisel Partners analyst Jordan Rohan has launched coverage of Latin American e-commerce play MercadoLibre with an Overweight rating and $70 price target. The stock closed yesterday at $50.14.
- “We believe MELI is one of the top-five secular growth stories on the Internet due to the growth in users, usage and monetization,” he writes in a research note. “While valuation appears high today, (translation: "don't worry about it, we'll come up with a new valuation method" or "cheaper than Baidu!") we forecast upside to near-term estimates and strategically the Pago payments platform distances MercadoLibre from competition.”
- Rohan expects MELI to post profits of $1.14 this year.
Disclosure: No position other than deja vu