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Stand clear as the Unicorn bubble unwinds

06112019_Uniforn Bubble

Stand clear as the Unicorn bubble unwinds

Growth investors are having a field day criticising the poor performance of value investing.  Their views have been bolstered by the booming price of some growth stocks – notably, profitless Unicorns – and research by two accounting professors,  found that not only had value investing failed for investors in recent years but that it had never worked.

Criticism of value investing coincided with a bubble in corporate bonds where over US1.1 trillion are trading at negative yields, meaning buyers who hold to maturity are guaranteed to lose money thanks to their purchase price being higher than the total of the principal and remaining coupons.

When the most profitable strategy has been to simply buy the stocks or bonds that went up the most last week or last month, without reference to what the underlying company does or its name, we know the clock is ticking.

Over the last 24 months, insanely valued but profitless software companies migrated to IPO stage cheered on in increasing frequency by a happy band of pre-IPO high net worth supporters.  As we have previously noted companies including Lyft, Uber, Slack, Peloton and many other Unicorns offered an exit for their early-stage backers who were constantly being diluted by H, I, J, K, L M N, O and P funding rounds without any plan for making a profit.

Low interest rates always lead to a misallocation of resources.  I have always articulated my concerns that if the world’s high net worth community were the only people with access to pre-IPO investing in Unicorns, who would be left to invest in the IPO itself? On top of that issue lay the fact that in the US, investors and staff in these companies have their shares escrowed for only six months, meaning a wave of selling was always on the cards. Indeed, a wave of Uber stock could hit the market this week when its escrow period (known as a ‘lock up’ in the US) expires. Uber shareholders, including company execs and VC investors will be able to sell their shares.

Is it any surprise that a lack of buyers, combined with a wave of sellers chomping at the bit, is going to produce negative share price performances?

In the last eight weeks, virtually every 1) high-profile, 2) VC-backed, 3) profitless, 4) Unicorn that IPO’d after December 31, 2017 has witnessed its shares sell off since their peaks this year.

We have consistently warned that stock market investors in Uber would not provide the same ten years grace and US$24.7 billion of capital that VC-backers so altruistically provided.  Those VC backers knew their payday would be selling out in an IPO.  Stock market investors don’t have that option and so they must see a runway to profits.  A lack thereof has always ended badly and always will.

Recent quarterly earnings reports disappointed and the appetite for risk dissipated.  Surprise Surprise, surprise.

When the fear of missing out replaces the fear of loss investors need to be vigilant, because the fear of loss always returns.

The unwinding of the Unicorn bubble will hit the shores of Australia just as surely as a pebble in a pond causes ripples that eventually impact the entire pond, and while low interest rates are supportive for stocks, woe be to you who invests in a company that won’t ever make a profit.

More on this subject coming soon.  Stay tuned…

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Roger is the Founder and Chief Investment Officer of Montgomery Investment Management. Roger brings more than two decades of investment and financial market experience, knowledge and relationships to bear in his role as Chief Investment Officer. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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3 Comments

  1. Hi Roger

    Have enjoyed your many articles and presentations on this topic. I’m guessing that the resumption of interest rate cuts by the US Fed Reserve accelerated the desire to list the unicorns. I am also thinking that the abandonment of the WeWork, amongst other IPO’s , suggests that the market has not yet entered a euphoric phase.

  2. Buffet comes to mind…

    In the short term the market is a voting machine (where razzmatazz dominates and unicorns ponce around), in the long term the market is a weighing machine (where the sheer mass of value crushes prior flights of fancy).

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