In a world where most companies need to achieve at least $1 billion in market capitalization just to get Wall Street’s attention, very few ever ascend the $1 trillion level, and arguably even fewer should.
Apple Inc. (NASDAQ:AAPL) and Microsoft Corp. (NASDAQ:MSFT) are now cozily entrenched in the $1 trillion market-capitalization stratosphere. It would take a 20-35 percent market crash to strip them of that honor.
But Amazon.com Inc. (NASDAQ:AMZN) repeatedly has tried and failed to cross the $1 trillion line. Jeff Bezos, Amazon’s founder, chief executive officer and president, just doesn’t seem ready to stop spending most of his profit on new ventures, which leaves the stock stalled below $2,000 a share.
And now, Alphabet Inc. (NASDAQ:GOOG) is trying to join the $1 trillion market-capitalization club. I was surprised to see it reaching for records.
After all, when it comes to the elite and large high-tech stocks, GOOG is the one that I most often ignore. It’s big, but boring.
Unlike AAPL or MSFT or even Facebook Inc. (NASDAQ:FB), earnings growth here already has hit a wall. I expect GOOG’s 4Q19 earnings report will tell a story more like AMZN than any of those other Silicon Valley giants: dynamic revenue and sluggish profit.
That’s what we want from a tiny start-up company eager to disrupt the world. When you have $1 trillion riding on your future, the start-up math no longer looks so attractive or even sustainable.
Cash Floods In, Cash Floods Out
Admittedly, GOOG rakes in a staggering amount of money from online advertising. But 80 percent of that cash goes right back out before it registers on shareholder screens, leaving the company less profitable than its market capitalization normally would imply.
GOOG at $1 trillion market capitalization commands a multiple of 27X 2020 earnings. If the business plan shifted to simply distribute those earnings to shareholders, it would take until the late 2040s to pay off the principal, much less pay any dividends above that.
Annualized and compounded, that’s only a 2.5 percent theoretical yield, which is barely keeping up with either inflation or Treasury bonds. Luckily, GOOG is also expanding, so what looks like 27X earnings now should be much more attractive in decades to come.
We pay a premium for companies with accelerated expansion prospects because we know they’ll grow into their multiples faster than the market as a whole. Then, when growth hits a wall and the time finally comes to pay shareholders back, we see that it was all worthwhile.
The problem is that GOOG is growing fast, but not fast enough to really justify its price. Right now, the profit pool is swelling at an annualized rate of 16 percent.
A year from now, we might have to put up with 14 percent growth. By 2023, GOOG may struggle to give us more than 10 percent.
And if my projections are right, GOOG still needs to command a 17X multiple to justify even its $1 trillion scale, much less give shareholders any appreciation in the meantime. That’s not a cheap stock. Historically, it’s a little more than what the market is willing to pay.
Consider what history tells us about GOOG. I think a lot of people still think of this as the upstart “Yahoo Killer” that changed the search engine business forever and broke the rules when it went public in 2004.
But we’re a long way from there. A few years after GOOG went public, the company already was worth more than $400 billion before the 2008 crash.
At that time, investors lined up to pay the equivalent of 100X earnings for these shares. It was worth it then. Profit doubled here between 2007 and 2009 and then never looked back.
The intervening decade has been a great ride for shareholders. If you bought in at $300, I would not recommend liquidating until the ride ends.
I just wouldn’t buy this stock this close to $1,500 and expect it to double again between now and 2030. There just aren’t that many ad dollars.
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Cannabis Corner: How a Short Squeeze Feels
It has been an encouraging week for cannabis bulls, with the core group of stocks I track rallying a staggering 21 percent since the last issue of Trading Desk.
Every single cannabis producer and distributor in that group joined the party. The weakest, Aphria Inc. (NYSE:APHA), reported a slight earnings miss and still surged 6 percent.
When the disappointments still run rings around the S&P 500, investors aren’t really looking at the underlying companies as separate entities. This is once again a pure thematic trade where a rising “green tide” theoretically will lift all boats.
That’s not really what’s going to happen. It is not healthy to punish great companies for the mistakes of their weaker competitors, which is what happened when that sentimental tide went out last summer.
And after watching unnaturally tight correlations between these stocks finally break, this feels more like a relapse than a reason to cheer. I don’t think this is a real rebound at all.
Instead, this is probably just the short sellers covering their positions and taking profits. As depressed as these stocks are, even that brief respite can unleash a whole lot of upside without changing the long-term trend.
We only need to look at Tilray Inc. (NASDAQ:TLRY) for a demonstration of how this works. That stock went from one of the hottest initial public offerings (IPOs) of 2018 to practically radioactive status. As I write this, short sellers now have committed to buy back 48 percent of the float.
In other words, they owe the market $150 million in TLRY stock before they can close their positions. Here in the new year, a few are cashing out. Nobody was willing to sell at $15 so the short sellers needed to raise the offer beyond $20, a stunning 35 percent above last week’s level.
The shorts can afford to look generous. Some of them opened bets against this company back in June when TLRY was a $45 stock. There’s plenty of room for this bounce to continue.
Naturally, the other Big Cannabis names were also heavily shorted, although not to the same extreme extent. They’re rallying too.
What I find encouraging is not the size of the bounce but the amount of shares the shorts still owe. A lot of TLRY shareholders evidently aren’t content to exit at $20.
They’re hanging on for better days ahead. That’s what I love about the market. Conviction counts. If the bulls are right, they’ll force the bears to surrender.
For now, we enjoy the relief and look to those better days.
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