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.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
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.
Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.
Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.
He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.
-
Should you invest in UK equities?
The FTSE 100 hit a record high this week, but UK equities remain unloved and undervalued compared to their global and US peers. Should you snap them up at a discount?
By Katie Williams Published
-
State pension errors: DWP urged to check for mistakes among divorced people
Former pensions minister Steve Webb says there are a high number of divorced women on low state pensions. Now MPs want the DWP to check if there were any errors in “potentially underpaying men and women who are divorced”.
By Ruth Emery Published
-
AstraZeneca CEO’s £1.8mn pay rise approved despite shareholder opposition
AstraZeneca hiked its dividend to persuade shareholders to accept CEO Pascal Soriot’s pay rise. Is he worth his salary?
By Dr Matthew Partridge Published
-
Adidas, Nike or Jordans - could collectable trainers make you rich?
The right pair of trainers can fetch six figures. Here's how you can start collecting vintage Adidas, Nike or Jordans now
By Chris Carter Published
-
The industry at the heart of global technology
The semiconductor industry powers key trends such as artificial intelligence, says Rupert Hargreaves
By Rupert Hargreaves Published
-
Three emerging Asian markets to invest in
Professional investor Chetan Sehgal of Templeton Emerging Markets Investment Trust tells us where he’d put his money
By Chetan Sehgal Published
-
What to consider before investing in small-cap indexes
Small-cap index trackers show why your choice of benchmark can make a large difference to long-term returns
By Cris Sholto Heaton Published
-
Why space investments are the way to go for investors
Space investments will change our world beyond recognition, UK investors should take note
By Merryn Somerset Webb Published
-
Time to tap into Africa’s mobile money boom
Favourable demographics have put Africa on the path to growth when it comes to mobile money and digital banking
By Rupert Hargreaves Published
-
M&S is back in fashion: but how long can this success last?
M&S has exceeded expectations in the past few years, but can it keep up the momentum?
By Rupert Hargreaves Published