There is no doubt that there is a significant amount of disruption going on in the economy, and that many industries will be reshaped in the next few years. That said, we think investors have discounted some older companies too much, while extrapolating growth too far for some start-ups.
This dynamic of overpaying for IPOs and unprofitable growth has created a situation that is very reminiscent of the .com bubble period, where overall market valuation looked incredibly stretched, but you could still find older companies trading at reasonable valuations.
Stocks in the US are currently trading as a group at a similar percentage of GDP to where they traded at the peak of the .com bubble.
After that bubble burst, many "old economy" shares significantly outperformed the market. Given the current setup we would not be surprised if that were to happen again.
Back then the boring utilities sector outperformed technology stocks by almost 60% in the aftermath. It is important to remember that is just the average. Many well picked value stocks delivered positive returns during that bear market, while overpriced shares dropped to a fraction of their previous highs.
Below we include some examples that have us scratching our head in disbelief. If you have some reasonable explanation please let us know in the comment section.
One industry that is experiencing significant disruption is without a doubt the automotive sector. Even then, does it really make sense for Uber to be trading at a market cap of almost that of Ford and Tesla combined?
Either we are getting autonomous electric taxis in a few years, in which case Tesla should be trading at a higher value than Uber, or these technologies will take a lot longer to become reality, in which case it would be reasonable for Ford to trade with a bigger market cap than Uber. Somehow Uber appears to be valued as if they can keep charging customers the same prices as they do today, but with a cost structure assuming driver-less cars.
Department stores are another sector of the "old economy" where negativity has probably gone too far. Nordstrom has earned a reputation as a well-managed retailer that was early in making digital investments. While it has experienced margin pressure, it remains solidly profitable and has quickly grown its online sales. In fact digital sales have been growing quickly and reached 30% in 2018, which is quite remarkable. This makes Nordstrom one of the largest e-commerce companies in the world, and would probably be valued much higher if it did not have the brick-and-mortar operations. We think giving the legacy operations a negative value is absurd, given that they remain solidly profitable and enable the implementation of an omni-channel strategy, including buy online and in-store pick-up.
For comparison, online luxury e-commerce Farfetch (NYSE:FTCH) now has a bigger market cap, which is quite surprising given that Nordstrom's revenues are an order of magnitude higher, even just its online sales are multiple times higher.
Beyond Meat is probably one of the most overvalued recent IPOs. I might give their veggie burger a try some day, but would not touch its shares with a ten-foot pole.
Defying all logic its market cap is approaching that of the largest grocer in the US, Kroger, which is an incredibly well managed and profitable company.
Looking at their revenues, it's clear that they are not in the same league. While Beyond Meat is growing quickly, its revenues are a tiny spec compared to those of Kroger, which are almost a thousand times larger. Let that sink in, we are talking about three orders of magnitude difference, billions to millions.
Incredibly, Netflix had a higher market cap compared to Disney for a while. While it's true that Netflix has had an impressive growth in revenue and subscribers, Disney has some of the best media franchises in the world. Netflix is learning just how expensive it is to create content, and how difficult it is to create content that can stand the test of time.
This is an example where investors are starting to wake up to the fact that the fast growing start-up does not necessarily have an entitlement to a new market, that they too can be subject to competition, and that sometimes the incumbent has some competitive advantages too. In Disney's case its rich library of content.
If we were forced to choose between the two we would probably still go with Disney, even though it has gotten more expensive in recent months.
With the high risk of recession in the next few quarters we believe this is not a time to invest in richly valued companies. The Estrella Mishkin model that incorporates the yield curve to estimate recession probabilities is giving an almost 30% chance of recession in the next four quarters.
This appears to be a threshold level that in the past has preceded many historical recessions in the US.
One advantage of several "old economy" stocks is that they seem to be discounting a recession to a large degree in their share prices, whereas a lot of the high-flying recent IPOs certainly do not.
For example, Kroger and Nordstrom are trading at enterprise value to revenue multiples that are just as low as they were during the financial crisis. Both companies are experiencing challenges and increased competitive pressures, but they currently remain solidly profitable.
The market as a whole is looking rather expensive at a time where the economy is getting weaker and recession risks are mounting. The market environment is reminiscent of the .com bubble days, where it is just assumed that new companies will dominate any market they look to disrupt, while the incumbents are being left for dead even when they remain solidly profitable and able to defend their turf.
Since many VC-backed companies and recent IPO's are paying for growth even when it is not profitable, it is possible that a recession might actually be beneficial to some "old economy" shares. For instance, should VCs stop throwing money at food delivery companies people would buy more groceries, benefiting a company like Kroger. In any case, all we are saying is that history has taught us that we should not be so quick to discard well run "old economy" companies.
Disclosure: I am/we are long KR, JWN. 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.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling investments you should do your own research and reach your own conclusion, or consult a financial advisor. Investing includes risks, including loss of principal.