How Covid-19 sparked the return of the day trader

Lockdown boredom has unleashed a horde of speculators on US stocks, with predictable consequences.

The difference between a bubble and a mania is hard to define, but most of us figure we know it when we see it, to borrow an American judge’s famous summary of pornography. The boom or bubble – according to your taste – in large tech stocks such as Alphabet, Amazon, Apple, Facebook or Microsoft doesn’t seem to pass that test. We can argue about whether they are overvalued, but they are clearly very valuable. At worst, they should be worth a good proportion of what the market now thinks. 

Some other trends look more like mania. Take electric-vehicle maker Tesla, whose share price recently passed $1,000, up from around $400 in January. Its market capitalisation of $200bn is now larger than Toyota’s; its enterprise value (see below) is just a third smaller than Toyota and 20% smaller than Volkswagen, and is larger than Hyundai, General Motors or Ford.

Toyota and Volkswagen both make more than ten million vehicles per year; the other three make six to seven million each. Tesla makes less than 500,000. Simply put, Tesla needs to grow production and market share vastly – or become hugely more profitable than its rivals – to justify its current valuation. That is conceivable, but very optimistic. If it fails, it’s worth a great deal less.

Putting a price on a parody

Still, Tesla is a serious company with a real product – just one that may be overblown. You can value it, even if uncertainty is high (see right). Then there’s Nikola, which initially sounds like a parody of Tesla (both are named after inventor Nikola Tesla). It plans to make electric and hydrogen trucks, but it hasn’t produced or sold any vehicles yet. I see no sensible way to value a stock like this at more than a pittance – it’s all blind faith. Yet since listing on Nasdaq, its shares have soared and its market cap is $24bn – more than Ford’s. 

Finally, there’s car-rental firm Hertz. Covid-19 has destroyed its business. It’s going through bankruptcy with $19bn in debt. It’s quite easy to value Hertz’s shares – they’re worthless. Yet the price soared from $0.8 to $5.5 early this month, before crashing back again.

What links all these seems to be a surge in US retail trading (daily trades at broker E-Trade were up threefold in early June), quite possibly driven by the shutdown of sports betting and casinos. This isn’t powering the whole recovery, but it is pumping froth into hot stocks and trash.

We’ve seen this before in the dotcom era. It will come to the same end. The unanswerable question is whether that will end the rally, or just be bad for the stocks that day traders favour, leaving the rest of the market unscathed.

I wish I knew what enterprise value was, but I’m too embarrassed to ask

The simplest way to measure the value of a company is to use its stockmarket capitalisation – the value of all its outstanding shares. However, this may not always provide a useful reflection of all the claims that different groups of investors have on a business.

For example, a company may be heavily funded with debt rather than equity. Conversely, it may have a lot of unused cash on its balance sheet offsetting some of that debt. It might also have preferred stock in issue (securities that rank above ordinary shares, but below debt) or some of its subsidiaries may be partly owned by other investors (known as minority interests). These last two factors are usually less significant compared to debt and cash, but could be important in some situations. 

For a fuller picture, analysis sometimes use enterprise value (EV), which puts together all these sources of funding. For example, if a company with a market cap of £5bn also has £3bn in debt, £1bn in cash, £500m in preferred stock and 25% of a subsidiary valued at £1bn is held by other investors, its total enterprise value will be £5bn + £3bn − £1bn + £500m + (25% × £1bn) = £7.75bn. 

Since interest on debt is paid out of pre-tax earnings, EV is usually valued against a metric such as earnings before interest and tax (Ebit), instead of net income. A lower EV/Ebit ratio implies a cheaper company, just like a lower price/earnings ratio.

Some analysts prefer to look at earnings before interest, tax, depreciation and amortisation (Ebitda) and value companies using the EV/Ebitda ratio, on the basis that removing depreciation and amortisation (which are non-cash charges) makes it easier to compare firms with different accounting policies. This can be useful, but be aware that a flaw with Ebitda is that it makes no allowance for maintenance capital expenditures (ie, the cost of replacing old equipment), which depreciation and amortisation try to reflect.

Recommended

The best offers for switching banks – get up to £200 free cash
Personal finance

The best offers for switching banks – get up to £200 free cash

Looking to move bank accounts? You can now bag as much as £200 for switching current accounts from two major banks
1 Dec 2022
UK stock market opening times: when will the stock market close for Christmas?
Stockmarkets

UK stock market opening times: when will the stock market close for Christmas?

Here is everything you need to know about UK stock market opening times during the Christmas period of 2022.
1 Dec 2022
December Premium Bond winners: NS&I reveals the jackpot winners
Savings

December Premium Bond winners: NS&I reveals the jackpot winners

NS&I Premium Bond winners announced – how to check if you are winner.
1 Dec 2022
Best regular savings accounts – December 2022
Savings

Best regular savings accounts – December 2022

You can earn an attractive rate on the best regular savings accounts. We tell you the best on the market to take advantage of right now
1 Dec 2022

Most Popular

Fan heater vs oil heater – which is cheaper?
Personal finance

Fan heater vs oil heater – which is cheaper?

Sales of portable heaters have soared, as households look to cut their energy costs. But which is better: a fan heater or an oil heater? We put them t…
21 Nov 2022
Best regular savings accounts – December 2022
Savings

Best regular savings accounts – December 2022

You can earn an attractive rate on the best regular savings accounts. We tell you the best on the market to take advantage of right now
1 Dec 2022
Wood-burning stove vs central heating ‒ which is cheapest?
Personal finance

Wood-burning stove vs central heating ‒ which is cheapest?

Demand for wood-burning stoves has surged as households try to reduce their heating costs this winter. But how does a wood burner compare with central…
29 Nov 2022