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    • I follow the public markets quite closely and I am interested in building valuation models. In the past, the rule of thumb was that 10X revenue valuations was reserved for the best companies. See Bill Gurley's seminal post on this:

      The valuation of the best public SaaS companies has gone up substantially, much faster than the rate of growth of their revenues. See:

      Example: Shopify trades at about 20X revenues whereas just a few years ago it traded at 10X revenues. You can go through the list and see this multiple expansion for a wide swath of companies (similar analysis can be done for other industries and for good companies this multiple expansion still holds). There is no rule of physics that states that good companies should be valued at 10X. All these rules come from the emergent rules of the world economy. But if the underyling assumptions change it is possible that the rule does not hold any more.

      The question on my mind is quite simply: are we in a bubble or is this normal? I have been trying to read about this for sometime; trying to understand the impact of QE and interest rates.

      To kick this discussion off, I'll focus just on negative yielding debt which is at a record high of $12T WW:

      There is a lot of concern that negative interest rates are bad and will have terrible side effects.

      Having thought about this for some time, my leading hypothesis is as follows:

      1. I don't see that big a difference between negative rates and inflation. Negative rates are more psychologically disturbing as we have never seen them. But inflation does the same to cash.

      2. There is possibly a very positive underlying long term trend. From every measure we live in the best time in human history:

      Could the negative interest rates really be a reflection of the fact that we have made great progress on the more well defined problems (reducing poverty, reducing infant mortality rate, etc) which have more predictable returns to them and that capital really needs to move to more unclear/riskier innovation (clean energy, space travel, etc)? I also wonder if the fact that negative rates have not spurred growth in the EU is also a reflection of risk taking appetite in the local economy; there have to be entrepreneurs who will be willing to taking crazy risks (when cost of capital is low) to invent the future, not just "distributors" who succesfully match supply to demand of known goods and services?

      I don't know if I am on the right track and would love for people who study this to educate and debate the issues. I have more data that I am happy to share if this panel grows.

      @Chris : are there people in the Cake community who are knowledgeable and can weigh-in on this topic?

    • Fascinating! Yes, we have some very knowledgeable investors like you, such as @afisher and @Drue . I'll send a list of others you can invite. In the meantime, I'll dig into the articles you've linked and have some things to say. 👏

    • I'm humbled to be mentioned in the same sentence as Alan in this context. This is a really interesting topic and I thank @dhirajkacker for kicking it off. I am by no means an expert on the peculiarities of the public markets, but I am of the opinion we may be seeing a bit of a bubble, especially in markets and on companies where investors are ignoring the "fundamentals" (which inlcudes profitability). Are public markets "fairly priced"? Reading your post, I am not 100% sure that is what you meant with your question. Public markets are always "fairly" priced unless someone is trading with insider information - each transaction represents a buyer and seller who have agreed on a price. But "fair" does not equate to "accurate" or "stable" or "sustainable." When markets (public or private) start ignoring warning signs about future profitability and are only chasing growth for growth's sake, I do believe they risk creating bubble stocks. This is particularly dangerous when the bubbles are linked across entire sectors and then filled with helium... the entire sectors tend to become overvalued and at risk of seeing all the bubbles burst (dot.com anyone?). 2019 was a bad year for IPOs IMHO because many late stage private investors, and in turn the IPO underwriters, started ignoring the fundamentals on a number of these companies.

      I'm not sure how negative interest rates impact all this. Possibly it makes conventional saving vehicles like money markets, CDs, savings accounts, etc.., less attractive, and thereby allows more money to flow into equities? I THINK, monetary policy (QE) and negative interest rates have just about run out of steam as ways of juicing the economy. I think of tools like monetary policy and inflation like cocaine. In very small doses they can make the economy feel really good and energetic and help break it out of a slump. But if overused, it begins to lose its effectiveness and the economy needs more and more of it just to sustain the illusion of normal growth. Alas, I am not an economist and I don't think takes my views on this seriously.

    • I refreshed myself on Bill Gurley's seminal piece, which I love, but I always wonder about the background wildcard of what the market values in the moment. He listed a lot of factors — growth trumping all — but I was surprised to see the fundamentals winning out with WeWork, Uber and Lyft, which were so hyped before their IPOs.

      By the way, a few years ago Bill had an interview with Sarah Lacy of Pando. She asked what type of company he was looking to invest in. He answered that he and most VCs he knew, were looking for an interest-graph company that sounded very much like Cake. I had several conversations with him about it but he wants to get in at a little bit later stage. HIs point was that people spend a lot of money on their hobbies and passions and they want a place to indulge their mountain bike interests deeper than they can with their family and friends on a social graph network.

      A couple weeks ago I read a WSJ story about analyst's predictions for 2020. The headline was a so-so year, which sounded like a weather forecast of 50% chance of rain given how varied the predictions were analyst to analyst:

      My own view of fundamentals has something to do with government policy. I'm skeptical that incentives that cause trillion dollar deficits, little investment in science and infrastructure, and an increasing shift of wealth away from the middle class and poor who buy the stuff we sell, is a good long-term policy. I felt that way in the Bush years too. So I'm leaning towards bubble.

    • To @Drue ’s q “I'm not sure how negative interest rates impact all this. Possibly it makes conventional saving vehicles like money markets, CDs, savings accounts, etc.., less attractive, and thereby allows more money to flow into equities?”


      Yes exactly. Interest rates define the opportunity cost of capital. Perhaps this is a point explaining for the broader audience. I am going to use some broad simplifications so everything may not be technically right but will be directionally right. I am shooting for ease of explaining.

      Let’s say there is $100 in hard currency available (typically called M0 money) and through issue of credit we make this $200. And then assume you can earn interest on this at a bank X% guaranteed, or you can buy stock in public markets which has higher risk but possibly higher return or you can buy real estate - lower risk than equities but also lower return. Let’s look at an extreme: If X = 20%, then an investor would not consider equity or real estate. This is guaranteed 20%. But when X is 0% or even negative it encourages investors to look more and more at riskier assets. That’s the simple link between interest rates equity valuations. There are only so many opportunities with good companies and accessible real estate that the good ones get bid up.

      So the main question in my mind is that ~10 years ago when there was hardly any negative yielding debt, good company would be valued at 10x (under many assumptions of margin structure / growth / competitive position etc), but in a world where $12T is earning negative yield is 20x for the same company rational?


      The next question is that are negative rates the canary in the coal mine? What contagion are they going to unleash? This is uncharted territory. I hypothesize (but I am not sure) that this could be a reflection of actually the world being in a good place. I would like to discuss this idea on this panel.

      To understand impact of QE and credit policy, in the above example: QE expands the $100 and the conversion of that to $200 is a reflection of credit policy - the two are linked through velocity of money calculations. We can go more into quantifying specifically how much has M0 (or M1/M2) grown due to QE (expansion) and changes in credit policy (which have been tightened quite a bit). It doesn’t matter that M0 / M1 is, it matters what all that is in relation to GDP.

      In general I ignore analyst reports and finance media. None of them have skin in the game to try and make causal predictions. My focus is on specific investment opportunities and trying to understand why and why not it can make money.

      In the last 10 years I have been more wrong in missing opportunities. I could not believe the valuations / I did not focus enough on growth potential in understating companies. Bill Gurley has been predicting a downturn since 2015 so I find solace in being in good company. But the misses have forced me to dig a little deeper into valuation models to try and understand what is driving all this.

      The simple conclusion is that companies that can find growth opportunities in a world that is much better than it ever was, are attracting the capital. But in the process a lot of companies with poor unit economics are being funded / supported. That is the danger in the system (Gurley has publicly pointed this out many times). But what is also true is that SaaS companies that have huge addressable markets, have, by definition, good margin structure and continue to show 40%+ growth are possibly valued correctly at 20X top line given $12T in negative yielding debt.

      The other contagion in the system is that while all these valuations could be rational, it has exacerbated wealth inequality. Those who own stocks and real estate get disproportionately more wealthy. Huge inequality is never good for society. While I don’t feel qualified to criticize the central banks for QE or lowering rates and I am willing to give them benefit of doubt that they had no other choice in order to pull the world out of 2009 crisis / the Euro crisis, these actions do contribute to the wealth inequality.

      I also sometimes imagine a world where everyone gets two square meals, has access to health care etc. We are closer to that world (even if that utopia is 100-200 years out) than we ever were. What would be our purpose if that happened? Our difficulties of today also create purpose - it gives us something to fight for; to define ourselves by. In that utopian world, we as the human species will have to find purpose through innovation and exploration. I wonder if the capital markets are forcing us into that direction today; they are giving us a glimpse of the future. Forcing us to see that risk free opportunities to make a modest return are getting fewer and that everyone will have to “invent” (take risk) to get a return. I wonder if this is the beginning of the end of indexing! (Keep in mind that I don’t say times lines - these are multi-decade changes at best, but who knows truly).

      Unchartered territory, IMO.

    • The simple conclusion is that companies that can find growth opportunities in a world that is much better than it ever was, are attracting the capital.

      That's a fascinating hypothesis, one I want to believe. You sound like Jeff Bezos, Bill Gates and Stephen Pinker. Gates calls Pinker's book his favorite. I loved it.

      Also, Hans Rosling:

      My question is, hasn't the world been the best it ever was before each major collapse of valuations, in 1929, 2000 and 2008?

    • Will check out the book but I couldn’t agree more with the preview.

      And I love Prof. Rosling / all the Roslings / Gapminder. They bring data rather than project their dissatisfaction.

      I am sure I am have been influenced by everyone you have mentioned and perhaps all I am trying to see is if the capital markets too are signaling this improvement in the human condition.

    • QE stands for Quantitative Easing and it is the way by which central banks pump money into the system and was used extensively post the 08/09 crisis to provide liquidity. Why is this important in this context? Consider a simple monopoly game where the total money available in the system is $1000 distributed somehow between all the players. There is a hotel to be bought and through negotiations it is determined that the fair price to pay that hotel is $100. Now the "central bank" comes in and just gives everyone cash and doubles the amount of money they hold. Nothing else changes (keeping this very simplistic). The fair price for the hotel is now $200 because the money in the system just doubled. This printing of money is Quantiative Easing and has been used by the Fed in the US to get us out of the 2008/2009 crisis.

      To get a sense of how much money has been pumped in take a look at

      (i have pasted the graph below as well; I am not able to format it into the body of the answer somehow.)

      The gray bars represent recessions. The Monetary Base (M0) has gone from $800B pre 2008 to about $4T now with a slight tapering off recently as the Fed pursued tightening. This is a 5X increase in money supply. The GDP in the same time period has gone from about $15T to $19T now:

      I don't want to keep going down a rabit hole but all this is incomplete without answering the next obvious question, with 5X more money and only a 25% increase in GDP ($19/$15 ~= 1.25), why have we not seen at least a 4X increase in asset prices and run away inflation, which has stayed steady at around 2%:

      The answer to that is full explained here:

      But in short, the amount of money in the system is a function of M0 and credit policy. In times where credit is given out easily, the same underlying dollar is spent many times over. This is the velocity of money. Since the 08/09 crisis, the credit standards have been really tightened and as a result the overall money to spend in the system is actuall lower, i.e. M0+credit pre 2008 as a % of GDP is lower than M0+credit now as a % of GDP. The gory details of all this are in the article above.

      So tight credit policy has reigned in inflation and somewhat counterbalanced the impact of QE, but low interest rates have pushed asset prices up substantially. And there is no prediction that interest rates will go up materially in the near future. In fact, if anything, it is being predicted that in the EU negative rates are going to stay for a while:

      “The ECB’s deposit rate will stay at minus 0.4% through 2021, projects Capital Economics, a consulting firm. It expects the Swiss to cut their rate to minus 1% next year from minus 0.75%. It expects Denmark, among the first to introduce negative rates in 2012, to lower its rate to minus 1% next year. By contrast, the U.S. Federal Reserve pays American banks 2.35% interest on their excess reserves.”

      ------

      Money supply in the US:

    • Amazing analysis @dhirajkacker. You are covering this from all angles. Nice to see the WSJ article that agrees with my theory that negative interest rates are an addiction.

      I tend to agree with your hypothesis that we are in the best of times, and I don't mean that in the way I think @Chris interpreted it in the sense as being the good times before the bad (sorry Chris if I misread that), but actually in the midst of a long-term trend of overall good times (so while I do think we are potentially in a bubble and some asset classes will either deflate or burst, those are temporary corrections on a longer term trend of things getting better for more people). I'm not sure, however, that the negative interest rates are a reflection of those good times as much as an addiction left over from the last temporary correction (08/09). But I am not nearly the student of this subject as you are.

      My two cents on all this: people who have limited assets and a limited income are hurt the most by negative interest rates because the only options for them to save are the ones that don't pay anything anymore. People who have significant assets can afford to diversify into asset classes that are riskier (exactly what you suggested in your original post). While this can be a GREAT thing for the future of humanity (think about investing in companies developing new modes of transportation, reducing CO2 in the process, or companies creating new ways to detect cancer, or create new FinTech products that democratize investment vehicles, etc..), a lot of "private" capital is also making unicorns out of companies with questionable products and business plans that don't really do anything of importance for society.

    • (side note: I do find it interesting that in pulling on the simple thread "are companies correctly/fairly/ valued OR are we in a bubble", you can't avoid the deeper societal and economic issues).

      But @Drue, I agree with you. I don't want to parse the overall comment but the thrust of what you say is true. This is terrible if you are not a beneficiary. The world is changing rapidly, the future is coming at us fast, globalization is going to accelerate and it leaves a lot of people at the edge very vulnerable. You can't tell a 60 year old factory worker who has worked diligently all their life for a good retirement to suddenly pick up software development because their job got eliminated. At the same time you also want people to work and have pride in what they achieve; it is a very human instinct to want respect from others and have self-respect.

      My mental model is that it is important, especially in developed economies, to not leave people close to the edge, not leave people two steps away from complete ruin. I personally believe that Universal Healthcare is a really strong safety net that is alredy provided in all developed countries and should be provided in the US. The biggest argument for it is that it will enable entrepreneurship. The entrepreneur who holds on to a job because s/he wants to have insurance for their family, may just take the risk if they don't have to worry about this. I have also been thinking a lot about UBI. It sounded weird at first ("how do you decide what is the right amount?" / "what about self-respect that comes from work?") and then you look at how broken means-based relief programs are and view it from the lens that in a complex rapidly changing world, UBI keeps people away from ruin and puts decision-making in their hands on how best to spend that capital. But I do agree that we have to think about everyone carefully and who we are leaving behind. I don't know if UBI is the answer but I can't dismiss it as I used to when first heard about it.

      So, is Shopify at 20X forward revenues valued correctly or not? :-)

    • I hear you about “bad” businesses attracting a lot of capital. The question I pose back is how do we design a system where people who get to decide what “bad” is are not chosen based on birth / class / permanent govt appointment etc.

      Is the system today perfect. Hell, NO! There are a million stats that show the issues: 2% of venture financing going to women, abysmal rates of financing to Black / Latino founders, extremely long feedback cycles to eliminate the bad players, etc. And yet this is the most “democratic” system designed to date where there is still some death, where people are equipped to tackle the issues (rise of women focused funds, underprivileged founder focused funds, immigrant focused funds, etc) and people like you and me can criticize the bad investments and put in our votes. None of this happens fast enough for any of us, but as (I think) Bill Gates said: “we over estimate the short term and underestimate the long term”.

      I have every reason to stay optimistic about future of the world. People can and are taking action to make it better. I can’t wait to see what 2050 will look like.

    • I hope I have convinced you that progress is not a matter of faith or optimism, but a fact of human history. In fact the greatest fact of human history.

      👆 Love that quote from Pinker’s talk.

      I’m with you on watching authors or listening to them on podcasts versus reading their books. I love books but...so many books, so little time. I don’t know how Gates reads so many.

      Btw, he’s a good phographer and SmugMug customer.

    • I'm all for letting investors or individuals make their own investment choices and would vehemently oppose any attempt at some self appointed or elected "elite" or "expert" dictating what is a good or bad investment. I just lament the herd mentality of much of the capital today... I phenomenon I jokingly refer to as "more money than brains"... but if people choose to make risky investments and lose their money in the end, that's their choice.

    • So, is Shopify at 20X forward revenues valued correctly or not?

      I tried to dig into that because I know something of them, but I couldn't understand what made them so special. I kept discovering analysis like this:

      But here's a company that I do follow very closely because Elon, Cybertruck, rooftop solar and just oh my God. So 6 months ago it was going illiquid and the short sellers were all over it. It was trading at $190. This morning? $429. And yet, these analysts who make their living predicting stocks, in the last few hours, days:

      So how do you make sense of it?

    • I think company valuation is nuanced, depending both on the nature of the company itself, its business model, and the current financial environment.

      Historically, mature profit-making companies trade at about 15X to 18X earnings (not revenue) in normal market conditions with normal interest rates (5% to 7%) and such. Today, however, mature zero-growth companies like AT&T and Exxon Mobil trade a bit higher than that at 18X (AT&T) to 21X (XOM) earnings. But they pay 5%+ dividend rates in a zero-to-negative interest rate environment, so high dividend-paying stocks will get bid up.

      Similarly, mature software product companies traditionally traded for about 4X revenue. Software companies have great margins - zero cost of goods sold - but revenue and earnings are frequently lumpy, tied to software upgrade cycles. Enter the subscription SaaS business model, which makes earnings highly predictable, boosting revenue multiples to 6X to 10X and beyond. Back in the day, only anti-virus companies used subscription models, but today, Microsoft, Adobe, Quicken and everyone else are moving or have moved to the subscription model.

      We also live in a time where many newer companies are in winner-take-all markets due to network effect or other exogenous conditions. For example, we all gravitate to a handful of social media companies such as Facebook and Instagram (also owned by Facebook), operating system companies such as Microsoft, Apple and Google (Android).

      What are fast growing, network effects, near monopoly companies worth? Clearly way more than companies with lower barriers to entry, so fast growing, network effects companies get much higher bids.

      In the old days, it took decades to build a network effect, winner-take-all companies such as the phone company AT&T and the utility companies. But with today's Internet companies, these competitive contests are settled much faster, taking years instead of decades to sort out.

      As a entrepreneur, what would you do if you had a growing network effects company? I'd gobble up a bunch of capital and grow as fast as I possibly could without the wheels flying off, and that's exactly why you see companies staying private much longer.

      Take sticky shopping cart companies such as Shopify, Square and Wix. While they theoretically have a lower barrier to entry, shopping carts are sticky; no merchant wants to swap out their shopping cart and catalog once it's been integrated into their website. So, it's a race to acquire as many customers as quickly as possible, and because of this rapid growth, valuations get bid up. You might scratch your head why earnings-less companies are so valuable, but in winner-takes-most businesses, it all makes sense.

      For years, Chipotle Mexican Grill could recoup their investment in "A" model stores - the most common format they use today - in about 10-12 months. With economics that compelling, as CEO you'd reinvest every nickle of profit into new stores, which is exactly what they did (until the e-coli scare). Zero earnings, but stores and revenue growing like gangbusters and a market cap reflective of that growth.

      As an investor, I've trained myself to investigate companies with sky-high valuations on the theory the market is telling me something. A good percentage of the time, you'll find a very fast-growing company.

      We live in a time of great innovation and business models are evolving...