Goldman Sachs And David Einhorn Disagree On The Market's Valuation

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 |  Includes: GS, SPY, TSLA, YELP
by: ADS Insights

Summary

David Einhorn is shorting a basket of high momentum stocks.

Goldman Sachs offers several reasons why the market is not overvalued.

Some stocks have lofty valuations while others have low valuations.

Nobel Prize-winning economist Robert Shiller has stated that the market may be in a bubble. So, is the market already in a bubble or on the precipice of one? David Einhorn of Greenlight Capital thinks that the market is already in a bubble and made that known in his recent letter to his hedge fund's investors. Einhorn believes that technology stocks are overvalued and revealed that he is shorting a basket of "bubbly" stocks. Some stocks with high valuations today include Yelp (NYSE:YELP) and Tesla Motors (NASDAQ:TSLA).

Goldman Sachs (NYSE:GS) disagrees that the market's valuation is lofty and thinks that today's market does not resemble the technology boom of the late '90s and early 2000s. To illustrate the impact of the past technology bubble, the Dow Jones and S&P 500 have both recovered and surpassed their highs, while the technology heavy NASDAQ still remains 25% below its all-time high reached back in 2000. This article will compare Yelp's, Tesla's, and Goldman Sachs' valuations against the valuation of the SPDR S&P 500 (NYSEARCA:SPY) in the present day.

What Einhorn thinks

Einhorn held out from shorting momentum stocks last year because he believed that their valuations were being driven by something other than traditional valuation methods. As he puts it, "...twice a silly price is not twice as silly; it's still just silly." But now he thinks that the opinion on momentum stocks has changed and that the market is in the midst of its second technology bubble in the last fifteen years. Here is a chart comparing the four investments' prices to their current earnings, next year's earnings, and book values.

P/E

Forward P/E

P/B

Goldman Sachs

10.4

9.5

1

Yelp

---

125

9.4

Tesla

---

60.2

38.3

S&P 500

18

16.7

2.6

Click to enlarge

Data source: Morningstar

Yelp and Tesla have not had any earnings in the past twelve months, so an investment in either two is more of a bet on a prosperous future than any past earnings or success. Goldman Sachs, on the other hand, trades at almost half the P/E of the market. Therefore, Goldman's earnings are a lot cheaper than the aggregate of all the companies in the S&P 500. The forward P/E's consider analysts' estimates for a profitable twelve months going forward for Yelp and Tesla, but even with earnings in the next year, Yelp and Tesla are generously valued. Perhaps, Yelp and Tesla are two of the stocks that Einhorn is talking about. Neither company has a full year of earnings up to this point, and the estimated earnings for them in the next year are quite expensive.

What Goldman Sachs thinks

Goldman Sachs took a contrary view to Einhorn's evaluation of the market with several points. One of the points that Goldman made was that the valuation of the overall market today is much less than it was in 2000. The S&P 500's forward P/E is currently less than 17 while it was 25 in 2000. Goldman also stresses that the index's P/B today is less than 3 while it was 6 in 2000. Another one of Goldman's reasons is that the market today is more representative of the economy and the companies that are driving earnings. The market valuation of the S&P 500 in 2000 was 33% technology companies, while those same companies only accounted for 14% of the index's earnings. Today, technology companies compose 19% of both the index's valuation and earnings. Goldman also makes the point that during the first quarter of 2000, 115 IPOs debuted on the market, garnering $18 billion. Conversely, 63 IPOs went to market in the first quarter of 2014, securing $11 billion in funding.

Whether or not Goldman is right, its own stock is selling at a discount to not only Yelp and Tesla but the market as well. In addition to having a lower P/E than the market, Goldman trades at a forward P/E of 9.5 compared to the market's 16.7. Therefore, Goldman may be undervalued and presents itself as an interesting investment opportunity. On a book value basis, investors pay exactly what Goldman Sachs is worth with a P/B of 1. Conversely, the market trades at almost triple the value of Goldman's P/B at 2.6

Who should we believe?

Einhorn has proved himself as one of the best hedge fund managers in the world, and Goldman Sachs has proven itself as one of Wall Street's best investment banks. Although Goldman does not think the market is overall in a bubble, both Goldman and Einhorn would probably agree that certain stocks are overvalued. Tesla and Yelp are only two examples of a slew of companies that have climbed on the hope that they will make a lot of money in the future, not because they generate significant earnings already.

If you hold stocks whose values are based more on their popularity than their financials, you should consider reducing your exposure and invest in more companies with tangible success. After all, even if the aforementioned companies' stock values were halved, they would still have lofty valuations. So, taking a cue from Einhorn - dividing a silly price in half may not give you a half as silly price, it probably just gives you a silly price.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.