2+2=7 In The Stock Market

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Amazon trades at a P/E of 250. Facebook is 40. For Air BNB, Tesla and Uber the P/E are undefined because they don’t have profits yet. The list goes on for many tech companies. The high P/Es reflect the rapid expected growth in profits and cash flow as companies like these disrupt the market.

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While all this disruption has been going during the recovery from the financial crisis real economic growth has been sluggish - averaging about 2%. That is a particularly low rate for an economic recovery. Nonetheless, the S&P 500 has risen by a factor of about 4 - ignoring dividends! That increase is not due to tech companies alone. Prices and valuations have risen pretty much across the board. As the Economist reported, P/Es of old line industries like hotels, credit cards, consumer proucts and so on are all well above historical averages expecting meaningful growth there too. This leads to the question, who does the market expect tech to disrupt. If the overall economic growth remains near 2%, the only way for tech company profits to growth far in excess of that is to take business from old line firms. But those old line firms are also expected to grow faster. It is as if
2 + 2 = 7. That arithemetic is another reason why I am worried about current market valuations.

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