Chart of the week
Requiem for a Dream
What does this chart show?
From 2000 - 2020, a portfolio of U.S. Internet stocks that began with Price-to-Sales ratios of 25 or greater went on to improve their sales by 1030%. Despite the impressive growth, the total return on this portfolio was only 16% as the stocks valuation multiples were crushed by 85%, almost completely offsetting the sales growth.
Why does it matter?
The optimism around internet companies and how they would change the world at the peak of the internet bubble turned out to be completely warranted. Sales of internet companies went on to grow at 12% annually for two straight decades as the whole world moved online.
Peaking back in history offers useful insights into the current wave of optimism that has surrounded investments into the promise of AI technology. As with back then, it’s not that the technology isn’t magic, everyone knows it is. It’s about the price an investor would have to pay for it.
Valuation expert Michael Mauboussin says, "The most important question in investing is what is discounted, or put slightly differently, what are the expectations embedded in the valuation? Understanding what has to happen for today's price to make sense is just such a fundamentally attractive proposition.”1
The Bottom Line
Those that care about the ‘total return’ portion of the chart are eventually forced to face the gravitational pull of valuation and should consider Mauboussin’s question.
Chart & Data Sources - Kai Wu’s great piece, Investing in AI: Navigating the Hype