All bubbles eventually collapse. This happened to dot coms, housing, Dubai and oil in 2008.
All inverse bubbles reflate. This happened to most stocks from March 2009 until now.
Despite this, the market never learns from the past. No matter how many bubbles we’ve had, we will always have new bubbles.
In addition to market-fuelled bubbles, Ben Graham, Warren Buffett’s mentor, has written about Wall Street manipulating stocks up and down many times over the decades, pushing them into bubble and inverse bubble territory. But, the manipulation can last only so long before the true value of the company is reflected in the stock. According to Ben Graham, all stocks eventually reflect fundamentals and a company's ability to generate PROFIT.
Would you buy a lemonade stand for $1,000 if it generated $1 profit per year? You would, if you knew that a greater fool will buy it from you for $1,100. But, eventually fools run out and all bubbles collapse.
The reverse also happens. Would you sell a shoe store for $10, if it was generating $3 profit per year? You would if you knew that everybody else is selling shoe stores for less than $10. But, eventually fools run out and logical people will want to buy your shoe store. This is because it would take 1,000 years to recoup their investment in their lemonade stands, whereas it would take less than four years to recoup yours.
1,000 years to recoup your investment? Does that sound so extreme that it’s ridiculous?
Revenue in 2010 (approx.):
JA Solar (JASO): $1,790 million
Priceline.com (PCLN): $3,085 million
Netflix (NFLX): $2,163 million
Salesforce.com (CRM): $1,657 million
Revenue growth from 2009 to 2010:
JA Solar: 211%
P/E as of May 31, 2011 (from Yahoo Finance):
JA Solar: 3.36
Assuming that both JA Solar and LinkedIn have flat growth, it would take approximately three years to recoup your investment in JA Solar from earnings and it would take 1,217 years to recoup your investment in LinkedIn. In 1999, dot coms and technology stocks had similarly ridiculous valuations. It became so ridiculous that AOL bought Time Warner (TWX). Eventually, the bubbles collapsed and their P/Es came into line. This happened to even the biggest companies, such as Cisco (CSCO) and Microsoft (MSFT) and their share prices have never gone back to their 2000 peak. The same thing will likely happen to bubbles such as LinkedIn and Salesforce.
Critics argue that high P/E companies are growing fast and therefore their P/E will shrink because E is expanding. However, what is the probability that their E will expand so much to the point of bringing their P/E down to something reasonable such as 15? The probability that the Chinese solar companies will do this is over 100% because their P/E is already much lower than 15. If you buy a company with a P/E of 300 or 1,500, are you investing, speculating or gambling?
If JA Solar had the same P/E as Priceline.com, its price would be $80.
If JA Solar had the same P/E as LinkedIn, its price would be $2,184. Moreover, JA Solar is growing faster than Priceline.com, LinkedIn, Netflix or Salesforce.com. Therefore, JA Solar should have a higher P/E than these other companies
However, as of May 31, 2011, JASO was at $6.03 (after a 6.3% jump due to Germany’s announcement to shut down all nuclear power plants by 2022). This is a perfect example of an inverse bubble. (I’ve used JA Solar here to serve as the example, but many Chinese solar stocks are in a similar situation.)
Furthermore, JA Solar gave explosive, crystal-clear guidance for 2011 that is backed by law. From JA Solar's website:
Full Year 2011 Outlook
Based on strong customer demand for JA Solar's products and a number of new customer wins, the Company currently expects total cell and module shipments to exceed 2.2GW in 2011, representing an increase of approximately 50% compared to 2010. Module shipments are expected to be approximately 500MW to 600MW. Sales contracts signed to date for 2011 delivery amount to more than 2GW, representing approximately 90% of the Company's expected shipments for 2011.
How many companies can say that?
Can Wall Street analysts show one non-solar company with numbers similar to JASO’s? I’ve challenged Herb Greenberg of CNBC and Eric Rosenbaum of TheStreet to this, but no reply. Nobody can name one company. Read more here.
Critics (manipulators?) argue that the European market is shrinking for solar companies. However, they rarely mention that the Chinese, Indian, American and Canadian markets are growing. China plans to double solar usage by 2015 and increase it by 400% by 2020. Chinese solar companies are beaten down because they are Chinese, not because they are solar.
The evidence for this is that even though many of the Chinese companies are growing much faster than the U.S. solar companies, the U.S. solar stocks enjoy P/Es of 14 to 60. However, this discrimination might prove to be temporary, as it was for Baidu (BIDU). One can argue that Baidu was an inverse bubble in its early years, when its stock price was relatively flat even though the company was growing significantly.
The premise with most bubbles is that most speculators believe that the price will always go up. This was the same premise that American homeowners had.
Conversely, the premise with most inverse bubbles is that most speculators believe that the price will always go down. Ben Graham and Warren Buffett have proved them wrong, over and over again with companies that have sound financials. That's how they became the greatest investors of all time.
Disclosure: I am long JASO.