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Pinning a value on big tech's top names. Not as easy as it looks
Markets vs. Monkeys. Who has it right?
Does the efficient markets hypothesis (EMH among friends) have any value when looking at tech companies in the enterprise and data centre world?
EMH does not mean markets are the efficient way of doing things. There is no implication at all that healthcare, scientific research or the military should be delivered by market processes. Nor, from the EMH, is there any indication that they shouldn't be.
And the distinguished Nobel Committee has been quite fun on this, awarding its famous prize to different economists tackling EMH in 2013.
Eugene Fama (who showed that it's gloriously correct); Lars Peter Hansen (who gave EMH statistical rigour); and Robert Shiller (who proved that EMH isn’t gloriously correct). So opinions are a little split on this.
What the EMH is saying, though, is that markets are efficient at processing the information about what should be happening in markets: to prices and such like.
It further comes in three flavours: strong (“all information is already in prices”), which nobody but the nutjobs believes; semi-strong (“all public information is in prices”), which is me and most free market style economists; and weak (“well, sure, information is in prices but the EMH is true only because it's tautologous”), which is pretty much everyone not a nutjob or me.
I’m not going to say the EMH is correct here: rather, try and see whether your industry and technical knowledge accords with what the financial markets seem to be saying. If so, then we've some evidence of the power of the EMH. If the answers are clearly wrong then great, we've still learned something.
The number we need to look at for our selected companies is the price earnings ratio. If the market (or an investor) thinks that a particular company’s profits are going to soar then they will value the company's stock at a high multiple of current earnings.
If, to the contrary, we think that the firm’s a bit of a dinosaur, not likely to grow much (but could be very profitable all the same) then that multiple of current earnings will be lower. That P/E ratio doesn't come from the dividends that are being paid: it's the profits of the company itself against the share price.
So, who are our lab rats? A combination of old-guard and up and comers, firms with dominant market share in their respective markets, trying to transition into each other’s space, and enjoying varied fortunes on growth and profitability.
All are in the enterprise and data centre space, or expanding into those markets.
From the old guard trying to move into the new, we’ve got IBM on a P/E ratio of 13 (numbers rounded, price at time of writing), Microsoft on 17, Oracle on 18, SAP on 24 and VMWare on 42.
Then there’s Google - a member of the new pack - on a P/E of 25.
Amazon and Salesforce are also in the same challenger space as Google, but here’s where they differ; their P/E is actually negative: they're not making any money at all in the recent results (these ratios are always from the latest results, not historical experience over time).
This is all a bit tricky, because a low multiple shows that we don't expect much growth in the future but a negative one shows that we expect oodles and gobs of growth. Those losses are as a result (at least perhaps they are) of our expectation that the company will grow into its cost structure, or is investing to do so and so on.
And yet, it’s Amazon and Salesforce who are rewarded with rising stocks and cooing headlines and analysis; Microsoft, Oracle, SAP and VMware, which are making money, are perceived as the ones who must change their games.
Do note here that this is the ranking that is provided by the interactions of everyone in the marketplace. That is, those who look only at financial issues, those with great technical knowledge and also those random monkeys throwing darts at the share prices in the newspaper.
Repeated experiments have shown those random monkeys outperform most fund mangers. This is actually one of the proofs of the EMH: there's no information you can discover that will tell you which way an individual price is going to go.
What we're interested in is whether that ranking, from declining old codger as ranked by the markets to thrusting young upstart with massive growth ahead, accords with your intuitions coming from a more technical viewpoint.
What say you? Do the markets have it about right or are financial markets packed with ignorance and cobblers? ®