Valuation Mania is back!

Party like its July 2021.

Hello Coffee drinkers!

I am also adding a voice-over for the first time, so please tell me if you enjoy it.

A year ago, I wrote about the crazy valuations of Draftkings, Virgin Galactic and Doordash. While a lot of unprofitable tech stocks have corrected, most are still very expensive. Even more egregiously are the latest earnings of the mega-tech stocks like Google, Microsoft, Apple and Amazon. While the market reacted negatively to Facebooks' earnings, it rallied for the rest. Amazon is up 13% after hours and Microsoft/Google were up more than 5% after their earnings. However, these were disastrous. It seems that the market ignores how inflation is impacting these companies. 

The difficult thing with inflation is that it also decreases the margins of companies. Due to rising commodities and wages, suddenly real profit margins change. Companies that over-expanded are suddenly seeing their earning deteriorate. In a bull run rising revenues are the only important metric. A company tries to grow as rapidly as possible and over-spending is often encouraged. As inflation rises, that quickly becomes a problem. Potential profits in the future become less important as they are eroded away by the decreased earning power. Inflation is at 9.1%, so a company would need to grow earnings 10% to not have negative growth in real terms. I think that today's valuations are just as expensive as in July 2021. Spotify still trades at around 100x FCF, while loses are accelerating. But let's look at the big hitters: 

Microsoft

Let's start with Microsoft. While their revenue increased 12%, operating income was up just 8% with Net Income being up only 2%. The strong dollar of course hurt their earnings, but given the problems of Europe, it might not mean revert very quickly. 
Bulls might point to the 40% growth of Azure, Microsoft's cloud product to justify the current valuation of it trading at 28x earnings. But just as revenues are increasing, so are the costs. Adjusting the net income for inflation, Microsoft had negative real earnings growth of 7.2%. But they are not the only one. 

Google 

Google had very similar revenue growth to Microsoft with 13%, but their operating profits were basically flat. Google's cost were out of control. As a result their net income declined 13% and that is without including inflation. If we adjust for that, our real income growth stands at negative 21%. Ouch. 

Apple

Apple's earnings were even more of a disappointment, given the bull's argument of a great brand moat. With 2% revenue growth and net income being down 11% or down 18.7% in inflation adjusted net income it truly is horrible, but sadly it is not the worst. 

Amazon

When I first read their earnings statement, I could not believe my eyes. Operating cash flow decreased 40% YoY and Free Cash Flow turned negative. The company had operating income of $3.3b and a net loss of $2b overall. While the net loss was due to the markdown of their Rivian investment, inflation adjusted operating income declined by 49%. What was insanity tho, was the reaction of the market. After hours, the stock rallied 13% adding a cool 160b in market cap due to rosy guidance and beating expectations. I am not sure about the expectations of others, but I do want a 1,24T company that trades north of 65x EV/EBIT to make money. And I want them to make more money than smaller ones. While Ford, Coca-Cola, Texas Instruments and Visa have different business models, these companies all had either more or slightly lower operating income than Amazon. Meanwhile even Visa is 1/3 the market cap of Amazon. 

Conclusion

I think that we are in a bear market rally. The current business climate does not seem to be improving, the consumer is hurting and we are seeing it in the margins of the companies. 

Are you telling me that companies that have negative growth including inflation like Apple and Microsoft and even negative cashflow like Amazon and Spotify should trade at 25+ earnings? I don’t think so.