Monday, August 17, 2020

"Are Tech Giants Trading like Bonds?"

Equities are the (theoretically)* longest dated paper and so should be most sensitive to the risk-free rate.

Quick, what's the difference between a bond and an analyst?
A bond matures.
Thank you, I'll be here through Sunday, be sure to tip the waitstaff.

From ValueWalk's Jacob Wolinsky via Slope of Hope:
The tech giants are trading at valuation ratios that are close to unprecedented for such large companies. Currently, Amazon trades at a nosebleed price/earnings multiple of 122. Apple’s multiple is 33 which is extraordinary for a hardware manufacturer. Netflix clocks in at 84. Tesla leads the pack at 752, but that is largely due to its miniscule earnings. Overall, it is hard to look at these valuations without thinking “bubble.” But there is another interpretation.

At Cornell Capital Group we asked: What if the major tech giants (and I would exclude Tesla from this group) are trading as if they were quasi-bonds? That is a combination of their technology, their market power and the impact of Covid is such that their projected earnings are virtually locked-in. They are largely immune from the risk of competition and the fluctuations in the economy. If that were true, then the discount rate may be a good deal lower than that implied by traditional asset pricing models. To get an idea what this means, let’s go back to the basics.

The starting point for constructing any discount rate is the risk-free rate of interest. For valuing common stocks, this is taken to be a longer-term rate. The most popular choice is the 10-year Treasury yield. Exhibit 1 below plots the yield of the 10-year Treasury over the course of 2020. The exhibit shows that Covid, and the government response to it, led to a decline in the yield from 1.88% at the start of the year to about 0.60% during the last several months. At that yield if one were to calculate a P/E ratio for the Treasury bond it would be 167.

Even if the earnings streams of the dominant tech companies are “bond like” they are still a good deal riskier than Treasury bonds. This means that the proper rate to discount their earnings is the Treasury yield of 0.60% plus a risk premium. The practical question is how big is the risk premium? Rather than try to answer that question directly, the approach taken here is to value two of the leading tech giants, Apple and Amazon, as a function of the discount so that readers can decide for themselves whether these companies are properly valued....
*See 11 U.S. Code Title 11, Chapters 7, 11, 12, 13 and 15 for exceptions.