Strategies: Tech Stocks Often Rise and Fall Together. They Shouldn’t.

There is risk in buying these shares, too, but of a different sort. It’s paramount for an older company to generate cash at a reasonable share price, and trying to “reinvent a company like IBM” — and shift it into a high-growth mode with big acquisitions like IBM’s planned $34 billion purchase of Red Hat — could be a dangerous waste of cash, Professor Damodaran said.

“An old company can’t run as fast as a young company can, and usually it shouldn’t try,” he said.

There are exceptions, though. In Professor Damodaran’s typology, Apple and Microsoft are ancient but have experienced rejuvenation, Microsoft most recently with the strategic turn to cloud computing taken by its chief executive, Satya Nadella. Apple had a second life with the return of Steve Jobs in 1997 and the subsequent births of the iPod and iPhone — though Apple is looking its age now, Professor Damodaran said. Both companies generate enormous amounts of cash, he said, and so can be valued with traditional stock analysis.

The Dangers of Magical Thinking

Sober analysis is critical to market health. Consider the damage done by bouts of magical thinking about the value of tech stocks.

In March 2000, for example, at the height of the dot-com bubble, the market gave Cisco Systems a value topping $500 billion, briefly making it the world’s most valuable company.

In a misjudgment of stupendous proportions, investors gave Cisco a greater value than 24 big companies combined — including Apple, Ford, J. P. Morgan, Anheuser-Busch, McDonald’s, Staples and Texaco.

What were people thinking? Apparently, that Cisco was worth an astronomical price-to-earnings ratio of 196.2 because it would grow at a breathtaking pace forever and become the beating heart of a transformed economy. That vision was revealed to be hallucinatory when the dot-com bubble burst. Today, Cisco trades at a price-to-earnings ratio of about 19.3.

While valuations are generally more subdued today, imprecise thinking about tech stocks abides, with troubling implications.

Article source: https://www.nytimes.com/2018/12/13/business/tech-stocks-together.html?partner=rss&emc=rss