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First and Always, Price

Posted By Barry Ritholtz On July 7, 2011 @ 7:30 am In Psychology,Valuation | Comments Disabled

There are stories everywhere about excesses and bubbles. None seem to focus on the key component to any asset purchase: The Price Paid.

IPOs: Are the DotCom 3.0 IPO [1] companies a bubble? I have no idea. Forget the alternative metrics coming out of Facebook, LinkedIn, Groupon or Twitter: What do they generate in terms of revenue? When will they be profitable? How fast are they growing? A slew of IPOs [2] after a long drought is not proof positive of a bubble, but the prices paid relative to actual metrics of profits, revenues and growth might be.

China: Is China a bubble? I have no idea. The circumstances almost suggest its the wrong question to ask. They are a centrally planned economy — not exactly the land of Adam Smith’s dreams — and will soon have 2 billion people. I suspect the China boom is to accommodate many of its youth leaving the farms. (I assure you the Middle East revolts caught the attention of Cina’s leadership).

Toxic Assets: Junk paper, bad mortgages, CDOs — is there a bubble in this paper still?I have no idea. But I do know that it depnds upon the prices paid. There is actually no such thing as toxic assets — only toxic prices. That mortgage at face value may be a giant loser, but let me pay 20- cents on the dollar, and its no longer toxic at all.

US Bonds: Are bonds a bubble? I have no idea. Historically, yields are as low as they have ever been. And as noted here [3] a year ago, momentum has been taking them higher, it is likely to end badly, and we have  precisely zero idea when the day of reckoning will be.

Stocks: What about current market valuation in the US — is that a bubble? I have some idea on that, and based on current earnings, equities are a bit pricey. The risk factors are if the next economic contraction were to be begin sooner rather than later, that could be problematic for valuations. A pullback in US economic activity would very likely see profits drop sharply. Not like 2007-09 plummet, but a precipitous fall nonetheless. And, the Fed and Congress having zero maneuvering room.

As fund manager Doug Kass says, price is what you pay, value is what you get.

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Here is something I do have an idea about: Just as every general fights the previous war, you Humans seem to focus on what just happened, rather than what might likely happen in the future.

Back in 2005, we were still reeling from the dotcom collapse. Yet after missing the biggest bubble in Human history, people were only then seeing bubbles. In fact, they were seeing bubbles everywhere. I termed it a “bubble in bubbles [4]” — which is a catchier version of the Recency effect [5].

Now we have a new round of bubble spotting, and I go back to my original question:  Is this a question of true bubble valuations, or bad psychology?


Article printed from The Big Picture: http://www.ritholtz.com/blog

URL to article: http://www.ritholtz.com/blog/2011/07/first-and-always-price/

URLs in this post:

[1] DotCom 3.0 IPO: http://www.ritholtz.com/blog/2011/06/startup-bubble-2-0/

[2] IPOs: http://www.ritholtz.com/blog/2011/03/new-tech-bubble/

[3] noted here: http://www.ritholtz.com/blog/2010/08/do-us-bonds-resemble-dot-com-stocks/

[4] bubble in bubbles: http://www.businessweek.com/the_thread/wellspent/archives/2005/04/a_bubble_in_bub.html

[5] Recency effect: http://www.ritholtz.com/blog/?domains=http%3A%2F%2Fwww.ritholtz.com%2F&sitesearch=http%3A%2F%2Fwww.ritholtz.com%2F&cx=015905226837203657063%3Ax1cwdcykvvw&ie=UTF-8&oe=UTF-8&cof=FORID%3A11&s=Search&q=Recency+effect&sa.x=0&sa.y=0#1116

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