It's Not Always a Bubble

 | May 08, 2014 | 3:16 PM EDT
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What gets the highfliers out of this mess? What pops the bubble for certain?

It's always pretty simple: earnings, real earnings, earnings per share.

We keep hearing people talk of bubbles. Most of these people have never blown them, let alone traded in one. They talk about bubbles for a variety of reasons. Some talk about them hoping that if we have one and it pops, they can forever say that they predicted it. This is the "I told you so" mob, and I get to hear from them all of the time, like the people who email me and say "I told you so" about Tesla Motors (TSLA) or Netflix (NFLX) or Amazon (AMZN), when they have been telling me so for 300% to 400% gains and would have been canceled if they had their own show. Canceled by popular disclaim.

Others say it because they are so far behind the averages that they need stocks to cool off, and they can do so by jawboning stocks down. I have always thought it imperative that the managers who come on air and say they don't like the market should also reveal:

  • How they are doing for the year.
  • How uninvested they are.

Someone who has been screaming bubble for a 40% or 50% gain in a stock or a market hasn't been right, and that has got to be mentioned. Maybe the bubble talk is all wishful thinking.

Still others characterize a market as a bubble because they don't understand that there are many markets and many different kinds of overvaluation to point out. There are, indeed, many kinds of bubbles; they are not all of the same. For example, there can be stocks that have established cult-like status, as was the case with Twitter (TWTR) before its bubble burst. That was just one of those "I love Twitter so I am going to buy the stock" retail bubbles that seemed natural, given that people liked Amazon (AMZN) and Tesla and bought the stock, and they made tons of money. Twitter didn't prove up to the task.

Then there are the short-squeeze bubbles, stocks that smart guys decided to short, and because of the peculiar nature of the way to get short -- you first have to borrow the stock from you broker and then you can sell it short -- you end up as part of a short squeeze. There were a huge number of people, led by the much-revered David Einhorn of Greenlight Capital, who thought that Green Mountain Coffee Roasters (GMCR), the maker of the Keurig coffee brewer, was a big fad destined to fade. Einhorn torched the stock back in 2011 for potentially bogus accounting and for the wherewithal of the product. But recently, Coca-Cola (KO) announced it bought a 10% stake in Green Mountain for $1.3 billion, and that caused the shorts to scramble, and it rallied from $80 to $124 in a matter of days, because many short-sellers felt they had no choice but to bring in a busted short. Coca-Cola halted what was a real good bruising the shorts had delivered. This one red-lighted the shorts.

Finally, there is the bubble in the software-as-a-disservice-to-your-portfolio stocks, formerly known as software-as-a-service stocks, those wonders that allow you to rip out Oracle (ORCL) or Microsoft (MSFT) or SAP (SAP) and replace it with a cheaper off-the-shelf version for travel and entertainment or accounting or human resources, or community banking -- you name it, they have an SAAS for it. We had conjoining bubbles in cyber-security, Internet commerce and early-stage biotech.

Each one got bid up, in part because the original software-as-a-service companies like (CRM) put up unbelievable numbers or because Amazon showed you that if you grow your business really quickly, you can get a gigantic valuation. In other words, you didn't need to show a profit. Or, if you started a biotech, an old-line pharmaceutical company might have wanted to buy your company for its drug pipeline. Or because there has been so much hacking, a company with decent anti-hacking software would most likely get snapped up by a Cisco Systems (CSC) or an Intel (INTC).

In other words, these bubbles all started out pretty legitimately. Many of these companies came public because they could get more money than they could in a takeover, because the public embraced them. Given that only a small amount of stock might be offered in an initial public offering, the stock could get bid up beyond all reason as the tiny float wasn't enough to sate the investor demand.

That's OK. Once you get that kind of straight-up move, you tend to attract short-sellers who get crushed, because a good earnings report creates more momentum buying. Ah, but all good things have to come to an end, because eventually the insiders who weren't able to sell on the deal want out. At the same time, the investment bankers go hunting for any company that looks like the winner and begs it to come public in a deal that the venture capitalists who are always looking to cash out are happy to comply with.

Next thing you know, you get what happened beginning at the end of February, when the valuations for these companies got stretched to the point that they really were true bubbles and the insiders hit the exits with gigantic deals -- think FireEye (FEYE) insiders trying to sell stock in their cyber-security concern at $96 but not getting it done until $82. Turns out the sellers who unloaded 14 million shares at $82 did well, because it is now at $27. All of this took place in astounding two months' time. Oh, and don't look now, but there are another 80 million shares that can be sold in two weeks' time -- that's when the lock-up expires -- and if this stock is a real bubble, then much of that stock will indeed come to market.

That's exactly what happened to decimate Twitter. The lock-up expired, and stock previously forbidden from trading flooded the market, knocking it back to where it finally hit my $29 non-bubble target that makes it so I no longer think you need to dump the stock.

Now let me be real clear about this. In 1999 to 2000, we did indeed have a bubble. Companies came public with no hope of profitability and with the sketchiest of financials. They came public exactly for the same reasons that occurred this year: Buyers were snapping up private companies at high prices, and the insiders realized they could get even higher prices from the suckers in the public markets, on the basis of funny things such as unique viewers and eyeballs, but certainly not profits. Then the acquisitions ended, the insiders bailed at any price, the money ran out, and they folded. More than 300 IPOs in a very short time went from hero to zero as the bubble burst.

Will that happen this time? No, and here's why: Unlike those 300 bogus companies of 1999-2000, many of these companies we are now laughing at and scorning could be profitable if they wanted to be. Believe me, if Yelp (YELP) decided it wanted to slow its growth, it would be profitable next quarter. Same with Concur Technologies (CNQR), Workday (WDAY) or so many of the others we talk about. They thought they could get away without showing profitability, because the market didn't require Amazon to show a profit. A terrific software analytics company like Tableau Software (DATA) growing at 80% didn't think that it would have to show a profit. But if it wants its stock to stop going down, it will have to. That's what's happened.

Now the reason I said Twitter might be able to make a stand at $29 is that it is conceivable that if it goes down too far, it will make for a good acquisition by an older company trying to get some growth. There's enough cash around and cheap money for that to happen. Not yet, but it could happen. No one would buy a bubble company. But these companies? They just became very overvalued. They will now swing not into bankruptcy like the 300 non-Spartans who failed, but into undervaluation, where the insiders buy, not sell, and the companies are bought by older companies that can finally afford them. The true bubble plays, though, many of which came public in 2014, could very well never get profitable and will run out of money and fold. So be it.

I say, know the difference between froth and worthiness, between bubbles and high valuations. Don't confuse them. They are two very different animals. 

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