Scientists use complex equations to describe the surface of a simple soap bubble. Fancy math to describe a rather simple object. Social bubbles are the opposite. Complex systems with simple explanations. No equations necessary.
I recently searched our 3,500 public company database, looking for investor hope and promise. In other words, highly-valued companies. I wasn't disappointed. I searched for companies with current stock market valuations over 10 times their annual sales. By comparison, most businesses sell for less than 3 times sales. Much promise. Even more hope. To exclude small, startup-type companies I restricted my search to companies with annual sales over $25 million and market values above $100 million. Of the remaining 2,800 companies, 114 made the final cut. Many are pharmaceutical and biotechnology companies, where real homerun potential exists. For that reason I won't pick on the biotech sector; it's far out of my league to be evaluating some PhD's science project. Some of these may hit the proverbial grand slam.
But, there were plenty of companies in very competitive industries, selling for what I'd suggest are gargantuan valuations. A sign of the times? Yes, robust times. One thing seems certain--we are no longer in a financial crisis, judging by the valuations that investors are putting on some of these businesses. Many of these highly valued companies are in up and coming, high-growth areas. Solar and Alternative energy. Electric vehicles. Cloud-based technology. Big data. 3D printing. Internet-based businesses.
For instance, Splunk. What, never heard of Splunk? Neither had I, until recently. Still not sure exactly what Splunk does. And I'm guessing that goes for some Splunk investors. Never mind, investors today value Splunk around $6.3 billion. Yes billion. According to Value Line, Splunk "provides an innovative software platform that enables organizations to gain real-time operational intelligence by harnessing the value of their data. Its software collects and indexes data at massive scale, regardless of format or source and enables users to quickly and easily search, correlate, analyze, monitor and report on this data, all in real time...the software addresses the risks, challenges, and opportunities organizations face with increasingly large and diverse data sets, commonly referred to as big data."
Huh? I don't know about you, but now my head hurts. I don't know much about big data, but I do know about big valuations. Splunk has a big valuation. Roughly $6.3 billion for less than $200 million of 2012 sales. That's over 30 times sales. Of course, Splunk speculators are betting on years, no make that decades, of growth. Which may or may not happen. Did I mention Splunk is still losing money?
Now ask yourself: self, if someone dropped $6.3 billion in my lap, would I buy Splunk? Probably not. But then again, many professional investors who bought Splunk aren't playing with their own money. No, they're rolling dice backed with someone else's dollars, and are perhaps less concerned with elevated valuations, and more concerned with beating the market and earning big bonuses. And many feel they can sell before the bubble pops.
Our advice? Don't succumb to the "greater fool" theory that another sucker will come along and buy at an even higher price. When the next IPO storms out of the gate, be careful with your wallet. Don't bet the farm. Remember, bubbles usually inflate slowly, but like a soap bubble, when they burst, all that's left is air.
-John Heldman, CFA