In Yesterday’s post we dealt with Bubbles and the ‘greater fool’ paradigm that almost always tends to operate in the case of financial bubbles. We also dealt briefly with Financial Pornography. It’s again important for us to note that most Bubbles come about primarily in situations when there is:
a) Some new Technology
b) Some new (unexplored, unexamined business opportunity)
The internet provided both of the above which according to most investment stalwarts caused the Internet Bubble.
Here’s a tiny example for you to demonstrate the euphoric frenzy of the bubble and how it was a complete deviation from the common sense that human beings possess. Here is where Facebook’s totally unwarranted valuation also comes into the picture. (albeit discreetly)
To give you a brief background, the US Stock Market had produced a return of 18% per year till the beginning of the Internet Bubble. So at the beginning of the Bubble, investors expected anything ranging from 15% – 25% from the market.
The following example is taken from a book called ‘A Random Walk Down Wall Street’ by Burton G. Malkiel.
Companies such as Cisco and JDS Uniphase were at the time widely touted as “the backbone of the Internet. Cisco at the time was valued at about $ 600 billion. If one assumed that the pace of growth with that base continued for 25 years and if one assumed the US National Economy to be growing at 6% per year over the same period, Cisco would have been bigger than the entire economy.
An obvious disconnect between market valuations and any reasonable expectation of future growth.
Cisco went on to lose 90 per cent of its market value when the bubble burst.
Thus I guess its important to look at valuations and couple them with an expectation for future growth to figure out if a company is grossly overvalued. This is probably one of the checks that one can take to prevent a bubble of sorts.
It’s probable that Cisco was so overvalued mostly because of all the technological mumbo jumbo surrounding it with respect to it being a backbone of the new economy. There clearly was very little thought and foresight on behalf of these drum beaters.
Ankit, hope that answers atleast a small part of the question you were asking yesterday.
I want to stress here that I’m no expert. I’m only going to try and work (really hard) to look at a variety of sources and present information to you in a manner that is fit for consumption and makes sense. So in a sense im only and aggregator but please do pass on more questions so I have an incentive to work doubly hard.
“I want to stress here that I’m no expert. I’m only going to try and work (really hard) to look at a variety of sources and present information to you in a manner that is fit for consumption and makes sense.”
You aren’t succeeding…
Beyond stating the obvious, it’s clear you read Random Walk recently or (more likely) you read a review for Random Walk…
I agree with LordHawHaw
and maybe i don’t wanna discourage you and your ppl at WATever (maybe i want
) but one thing is sure that you people just aggregate info from all GOOD news blogs and some business books but the problem is instead of making the info better(by adding something to it or refining it) you people make it worse.
frankly my feed reader shows me something from contentsutra or maybe alootechie and then follows the feed from WATBLOG and as always the piece of news presented on the above blogs in crisp way, i find again on your blog in a form as if some kid was given a topic to write a 500 words essay and you ppl posted it here.
don’t improve, just start making some SENSE guyz.
it’ll earn you some credibility!!
Yesterday’s post was insightful to say the least but I felt you guys left out one of the most fascinating historical examples of “a bubble”. Long before the Qualcomms, Ciscos or the other high-tech stocks there was the Semper Augustus. In Holland this type of tulip was the “new black” (I’ll refrain from saying Facebook) of the 17th century. The “history lesson” starts when around 16-something a single bulb of a famous tulip variety could cost as much as a 1000 Dutch florins (the average yearly income at the time was 150 florins) .. I’ll refrain from referring to Slide’s valuation as well. But thanks to market mechanics …the price went up .. created a bubble and …(Rest of the story/details can be found on Wikipedia) .. (I loved history lessons but was never a fan of long ones).
Rather than rambling on … history should have taught us that there is a fundamental difference between perceived value and actual value. Though there will always be a quantitative difference between the two (otherwise we wouldn’t have markets) ridiculous differences between the two or a bubble always seems to be created by “that” investor that seems to have more access to media (I use this term loosely) than information making them more prone to hype. This is a very simplistic view, but I’m a firm believer of “wheel in what you deal” (know what you are investing in) … not …“cartwheel in what you deal” (leave that to the circus clowns).
@ Lord Hawhaw: Im currently reading A Random Walk. Apart from that im reading 4 others (in the previous post i stated 2 others). Im not keen on hiding my sources and im pretty clear about the fact that this IS complied information. In my opinion its relevant!
The point is TO state the obvious. Because obviously that was lost then. Over the course of a series if i can touch upon things like ‘the greater fool theory’, ‘financial pornography’, the impact and importance of ‘internet mumbo jumbo’, the role of financial analysts and how they can sell their souls, and a few other things about Irrational Exuberance (which is the title of another book im reading by the way).
If it didn’t impress you im fine with it. I’ll try harder to make it more relevant. If there’s anything that makes it more relevant for you – do let me know. I hope your criticism can be a little more constructive next time
. Makes your time commenting worth it and makes my time, reading the comment – worth it!
@Amit – our editorial style is obviously different from the above mentioned blogs. And its a conscious decision (if you hadn’t noticed). And obviously some people think we are making sense (and have some credibility). Check out http://www.watconsult.com for our list of clients
. I’ll be sure to consider what you said. I guess the ‘about’ column is colouring your prejudices.
@Nav – your view though simplistic is actually on of the core’s of avoiding a bubble – right?
Yea i thought i should right about The Tulip – Bulb Craze but i decided against it since this is a technology forum
. But thanks for bringing it up.
There was also the South Sea Bubble and the Conglomerate led bubble if you wish to undertake a few more history lessons. But you’re right – its about identifying the intrinsic value through various measures rather then letting the clowns do it for us.
I think situation A mentioned in the blog should fold up with situation B. Ultimately a new technology is an unexamined business opportunity. For e.g these days mobile TV is a new technology whose business feasibility is not yet understood.
In late ’90s internet was unexamined business opportunity. The latest bubble of financial markets – subprime crisis was another unexamined business opportunity when banks started giving loans to subprime leading to a default and therefore the crash.
True Rohit. I think i’ve mentioned the 2 separately because there are certain nuances associated with new technology. The kind of euphoria that is created around new technology is slightly different as compared to the euphoria created with new business opportunities like the subprime crisis or the Tulip Bulb craze or the South Sea Bubble. But you’re right Situation A always folds up with Situation B. The way analysts beat drums and advocate things is slightly different. Both involve speculation however. A lot of it.