When market hordes chase themes, who needs analysts?
In the past, equity analysts would use price-to-book ratios to value distressed companies, price-to-earnings on traditional sectors, and price-to-sales for growth stocks. These days, they have to be more creative
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It's an especially dicey period for research analysts at the biggest investment banks
Bonus season is upon us - time to get the numbers telling us if we still have viable careers. It's an especially dicey period for research analysts at the biggest investment banks. As things stand, they don't need compensation figures to see that their jobs are increasingly superfluous.
In the Covid-19 era, investment 'themes' - cryptocurrency, electric vehicles and stay-at-home consumer tech - matter a lot more than fundamentals. Case in point: Just days after Nassim Nicholas Taleb, an authoritative voice on black swans, ranted on Twitter that Bitcoin had been taken over by 'Covid denying sociopaths' and that he was getting out of that trade, the price of the crypto rallied to an all-time high of $50,000. The compulsion of the herd overwhelms any kind of sober research. So, what can be expected of the average equity analyst, whose media influence is not anywhere close to Taleb's?
To remain competitive in an ever-rising market, analysts in the hot, thematic sectors are starting to deploy non-traditional valuation metrics. In the past, equity analysts would use price-to-book ratios to value distressed companies, price-to-earnings on traditional sectors, and price-to-sales for growth stocks. These days, they have to be more creative.
Behold price-to-narrative ratios. China's electric vehicle maker NIO Inc. and food delivery app Meituan are examples of stocks with allure for the investing hordes. Though it's sold just over 80,000 cars, NIO is already a $93 billion large-cap company. Meanwhile, Meituan boasts of a $337 billion market value, with a valuation of 107 times 2022 earnings. Both are among the top holdings of the MSCI Emerging Markets Index and have become must-own stocks for any emerging markets mutual funds and ETFs.
To match that appeal with a touch of research, sell-side analysts have set an average price target for NIO of $65.07, about 40 per cent above their fair value at the end of 2020 and a good 9.9 per cent above the market price, data compiled by Bloomberg show. Similarly, the average price target for Meituan, followed by 54 analysts, is just 7.7 per cent shy of the prevailing market price. Can these be justified by traditional metrics?
Here's an example of how the alchemy works. In a January 28 report, Morgan Stanley valued NIO at $80 per share, declaring that electric vehicle manufacturers are "on the verge of a profound model shift" from just selling cars to generating high margin, recurring software and services revenue. Software is the key word. The auto industry's value used to be measured by the number of cars sold but if an EV maker can also be considered a software company, which has much higher valuation multiples, then that auto maker would be worth a lot more. While Morgan Stanley values NIO's long-term vehicle business at 30 times price-to-earnings, its software operations is worth 51.9 times price-to-sales. As a result, that chunk of NIO's operations can account for roughly a fifth of the company's terminal market value, even though its sales are just tiny 2 per cent.
There are other ways to make enormous valuations more digestible: by using discounted cash flow and forecasting rosy profits decades down the road. Daiwa Securities Group Inc., for instance, projects NIO's cash flow all the way to 2040. The bank sees NIO's earnings before interest and taxes at 213 billion yuan ($32.98 billion) by then, over 60 times the 2025 figure. That valuation method gives you a lot more upside than a simple forward price-to-earnings estimate. Daiwa has a street-high price target for NIO of $100.
Or how about using sum-of-the-parts analysis to value new business initiatives that are still burning through cash? This seems to be analysts' go-to method for Meituan, whose shares have rallied 49 per cent this year, thanks to strong southbound buying from mainland investors. The market seems excited by Meituan Select, a fast-growing e-commerce grocery where people band together to buy food and household goods at better prices. Chinese consumers, especially in smaller cities, started to embrace buying fresh food online during the pandemic, opening up a big untapped $1.3 trillion market.
But Meituan Select launched just last July and doesn't have much of a track record to speak of. Still, analysts from HSBC Holdings Plc. to Citigroup Inc. to Goldman Sachs Group Inc. have latched onto sum-of-the-parts analysis to reflect market enthusiasm. Already, Meituan Select accounts for 20 per cent of HSBC's fair value assessment of Meituan itself, for which the bank has set a street-high target of HK$550. Meanwhile, "new initiatives" account for 44 per cent of the sum-of-the-parts fair value at Goldman Sachs. With 50 buys, four holds, and no sell, sell-side analysts are buying a grocery e-commerce story that remains to be told.
An analyst's life can be tough. With a market awash with record-high liquidity, anyone who uses fundamental analysis will have to undershoot the prices the market is notching up. At the same time, analysts are loathe to alienate hot companies with sceptical views because they might just cut off your access to management and some real insight into performance. So everyone weaves entertaining tales, regardless of how realistic they are. The stories may keep customers enthralled for a while. But is this what you can build a career on? (Bloomberg)
