The Market Has Put You on Notice

 | Jul 24, 2014 | 1:00 PM EDT
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The good thing about the stock market is that prices and information are provided in real time on a daily basis and -- for the most part, those prices reflect all known information. The bad thing about the stock market is that prices and information are provided in real time on a daily basis -- and, for the most part, those prices reflect all known information.

So you can't blame the market if your investments go sour. The market puts you on notice each and every day. A better-than-expected earnings report has Facebook (FB) shares up nearly 7%, valuing the company at nearly 100x earnings and $200 billion dollars. The market is not hiding anything.

Fans of Twitter (TWTR), who were buying shares for $70, were not duped by the market. It was evident to those who were buying Twitter then, that they were valuing a company with no earnings at more than $40 billion. Now the shares are trading for $37, and the company is valued at $22 billion. Nothing has really changed except that some investors have learned a painful lesson.

Amazon (AMZN), which is perhaps one of the finest businesses today, is not such a fine investment. I don't want to sound like a broken record because the stock is trading at more than 500x earnings. Amazon is not going anywhere and with a market cap of $168 billion, compared to Wal-Mart's (WMT) $250 billion, it's likely that one day Amazon could eclipse Wal-Mart's size. But it's unlikely that  that will happen anytime soon. So while the future growth of Amazon is very bright, its upside is quite limited. More so, the downside risk if Mr. Market loses optimism is severe.

The concern about valuation is not only limited to technology stocks that seem to be forever branded thanks to the net bubble. For example, Starbucks (SBUX), which is facing historically high coffee prices, has a $60 billion price tag and an EV-to-EBITDA value of nearly 20x.

The understood law of expected return is that the higher the price of an asset, the lower the future expected return. Investors tend to forget by investing with a rearview mirror mentality. Excited by past future performance, they develop unrealistic future expectations. Indeed, past performance is not an indicator of future results. The market has provided notice.

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