Bubble Stock Meltdown
Revisiting the Bubble 500
By: Johann Colloredo-Mansfeld & Dan Rasmussen
In mid-2020, we identified a group of stocks with what we thought were insane valuations and atrocious financials in hot sectors from gene editing to electric car charging. We called these stocks the Bubble 500. A few months later, Jeremy Grantham published an influential essay identifying a bubble in corners of the US equity market.
But we were wrong. Dead wrong. Figure 1 shows that from when we wrote the piece to August 2021, an equal-weighted portfolio of these companies was up more than 60%, edging out Cathie Wood’s ARK Innovation by some 10% and handily beating the S&P 500.
Figure 1: Bubble 500 Index, ARK Innovation, S&P 500, July 2020 – August 2021
Source: Capital IQ, Verdad Analysis
Some of the individual companies soared. Shares in FuelCell Energy (NasdaqGM:FCEL), a company with negative net income and $70M in revenue, grew ~10x to a market capitalization of $8.7B. Blink Charging Company (NasdaqCM:BLNK), a provider of electric vehicle charging equipment with negative net income and $15M in revenue, grew ~11x to a market capitalization approaching $2.4B. MicroVision (NasdaqGM:MVIS), a company developing lidar sensors for autonomous driving, generates $2.3M in revenue but traded as high as $4B on ~14x growth in share price.
As we noted in our piece on bubbles, smart people tend to be early to call bubbles. Peter Lynch, Ray Dalio, and Howard Marks all started warning investors of a bubble in internet stocks as early as 1995. So at least we’re in good company in calling this bubble too early.
Two weeks ago, Jeremy Grantham renewed his calls of a bubble: “Today in the U.S. we are in the fourth superbubble of the last hundred years…. The checklist for a superbubble running through its phases is now complete and the wild rumpus can begin at any time.” And so, we’ve decided to double down as well.
Because now the Bubble 500 stocks are finally crashing. FuelCell is down 85%, Blink Charging is down 66%, and MicroVision has lost 88%. The Bubble 500 is down 25% over the past few weeks. Cathie Wood’s ARK Innovation, which owns many of these names, is down 54% since its peak in February 2021 but has only just made a round trip back to July 2020 levels.
This breakdown is significant, especially for growth stocks. Remember, growth stocks trend, and value stocks mean revert. The psychology is simple. People hear about a hot stock that’s gone up 3x, they buy some, it goes up 2x, they buy more: the whole attraction of buying a hot growth stock is the historic return trajectory. Value stocks are the opposite: you do well buying them when they’re down, as our Crisis Investing piece showed.
And so, once the trend gets broken, once the magic of the rising stock prices disappears, it’s a long way down until valuation becomes the justification for buying. And the Bubble 500 stocks still trade at wild valuations: FuelCell trades at 16.8x revenues, Blink Charging trades at 44.3x revenues, and MicroVision trades at 161.3x revenues. The median company trades at 12.2x sales, offers a -2.5% earnings yield, -7.5% return on assets, and -14.0% net income margin. Analysts remain bullish, assigning the median Bubble 500 company two-year forward revenue growth estimate of 20.8%.
Figure 2: Growth, Value, and Profitability Measures, Bubble 500, January 2022
Source: Capital IQ
There are growth investors who want to buy hot trendy winners and value investors who want to buy bargains. And there’s a long way between a 12.2x revenue multiple and, say, the sub-7x EBITDA multiple that Verdad and other deep value investors love.
Spreads between growth and value, in fact, are near all-time highs, which bodes poorly for growth once the crash gets underway. Figure 3 shows the ratio of the EV/EBITDA multiples of the most expensive three deciles of US stocks to the cheapest three deciles of US stocks since 2015.
Figure 3: Growth vs. Value EV/EBITDA Multiples, December 2015 – Present
Source: Capital IQ
And one final note: one key argument for growth stock bulls has been an accommodating Fed. But is that really true any longer?
We called this bubble too early. And we admit it. And perhaps we’re wrong again here. But growth has had such a good run the last decade, and the excesses are just starting to be purged. It’s not hard to imagine a scenario where this rout becomes a replay of the early 2000s tech bubble bursting, all of which would suggest highly valued growth stocks could have a ways further to fall.