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today i want to talk about what i've learned about the importance of [Music] [Music] valuation welcome back everyone my name's paul now i'm new to investing and believe me you should never take anything that i say as gospel pretty much every week i learn something new about the stock market and these videos help me consolidate it into my brain and hopefully some of the information that i find and the way i explain it might help a couple of other people as well because everyone learns differently and this is mainly for people who want to learn in the same way i do and this week i've learned a lot about valuation now i'm not going to go into detail this week about how i value companies i'm going to save that for like next week or the week after because that's going to be a really long video but before i start just going out and valuing companies i need to understand the importance of valuation and there's no better time to discuss this than right now because i don't know if you've noticed but so many people are making massive gains in the stock market and lots of experts are talking about how all the companies are completely overvalued people are paying way too much for them there's absolutely no underlying fundamentals that are propping these stocks up and then on the other side like the youtubers and all that they're saying that these companies are gonna go much much further and you should just hold on because it's gonna get a hell of a lot better and to a point both sides right but it's getting a bit out of hand now and i'm saying this right now in january 2021 but this could go on for years and it's this article from cnbc this week which i thought was very interesting the wealthy are investing like a market bubble is here or at least near this is where things are starting to get scary because wealthy people a lot of the money are keeping themselves in cash they're not contributing to things like tesla and square and all that sort of stuff it's mainly the retail investors that are pushing up the prices now and there's only really been one other time in recent history where things have started to play out like this and it's the dot-com bubble i've been doing a lot of reading up today and i've found a few interesting things that you might want to know the price to earnings ratio of the dot-com bubble was 46.71 that's right at the peak of the dot-com bubble and at the moment we're actually nowhere near that we're only 37 times earnings i mean that's still pretty high don't get me wrong but we're not at dot-com bubble valuations yet and believe it or not this is the main case that's against the bubble people who believe or at least tell people that they believe that a stock market bubble isn't coming use this information as a reason to say ah it's not that bad have a look because the p e ratios of the stock market right now are a lot lower than the dot-com bubble they are just keep buying guys and what i'm finding in particular on the comments in the discord and all that sort of stuff is that people love telling us about how much they're up they love saying oh i'm 400 up on this or i'm 800 up on that and rather than talking about how good the company is they're just focused on the price and in turn that makes someone else scared about the price they think oh i should be getting that too and everyone now is trying to find the next tesla or amazon and the trouble is there aren't many teslas and amazons in fact there's never been a tesla there's never been a company that has gone so overpriced so quickly that stayed there and spacks are brilliant for arbitrage arbitrage is like a fancy way of saying if you buy something it will definitely go up because if you buy any spec right now and it says it's going with an ev company that price will go up everyone is buying it and if you just go through the youtube videos it's all gross stocks 10x buy now best penny stock to buy in 21 time sensitive oh my god that's harsh oh who is like saying ah quickly buy now before you miss out oh god that's awful but it's all like double your money 10x and there's thousands and thousands of views everyone is just trying to jump on the next big thousand percent growth start do we not think this is getting a bit crazy because if we go back to the dot com ball we see a full list of ipos and spacks that all went bust or at least basically went bust there was loads of them and right now there is absolutely nothing to suggest that history will not repeat itself i haven't seen any solid concrete evidence that this isn't going to blow up in everyone's faces could i do a quick case study with you because i found cisco and the parallels with today's market are so so close now in case you didn't know about cisco cisco is a company that i just thought made phones every time i've worked in office there's been a cisco phone in front of me and i thought oh that company makes the phones but when you look into it cisco is so so much bigger than that cisco ipod in 1990 for 224 million it was a company that basically invented the internet router cisco in 1990 was the company that was going to let everyone access the internet the internet is the biggest human technological evolution ever in history cisco had the routers it was improving the routers and its exponential growth on the sales of these routers and how much it was going to change the world was massive and if we just stop it right there does that sound familiar to anyone cisco's run went on through the 90s it improved its routers and it was doubling its revenue every single year it had a huge exponential growth in sales in 1995 2.2 billion in revenue in 1996 4.1 billion in revenue 1997 6.5 billion 1998 8.5 billion this company was growing at a ridiculous rate and is growing at almost exactly the same rate as tesla and in march 2000 cisco was the most valuable company in the world rated at 569 billion this is what people were willing to pay for cisco at this time they were thinking that the internet's coming it's going to change the world its revenues are going to continue to grow forever which they all did cisco had amazing ideas of these routers going into all these businesses they were eventually going to spread it out they were going to become the internet of things that was the plan and according to that time their ceo was an absolute genius at the time the amount of employees cisco had was increasing rapidly as well and what was most important is all those employees had shares in the company much like many tesla employees do now i know what the maddest thing that i did find was what people were saying about cisco back in 2000 like this article from march 2000 firm's market cap is climbing to one trillion and all you have to do is read the first sentence one trillion dollars that's how much at least one analyst believes cisco systems will be worth in a few years one trillion dollars let's take a look at this article from january 2020 tesla could eventually reach a trillion dollar valuation think tank says and let's look at the first line of this article tesla to one trillion one think tank is toying with the possibility of it being one trillion dollars that's how much one analyst believes that cisco systems will be worth in a few years the parallels are absolutely crazy and i know i'm just picking out tesla right now and i have to say i know tesla is more than a car company it's a battery company it's going to go into all these things full self-driving much like cisco was more than an internet company but it wasn't just cisco that went down it was intel and microsoft two of the biggest and overvalued companies of the time and if you invested a thousand dollars in cisco stock at the dot-com bubble peak it would still only be worth 762 dollars that includes dividends it's paid and i cannot stress enough this video is not a video about how crap tesla is tesla is not crap tesla is one of the most amazing companies in the world and it will be worth more in 10 years so stick with me because i fully believe everything that the smart tester investor says and in order to really figure out where we are with tesla we need to understand how a company grows so this is my very poor drawing of what we call the corporate life cycle we have a monetary amount here that we know what the company is worth or the amount of money that the company is going to make that's a very important thing you have to remember which i don't think a lot of people consider you have to figure out how much the company is being valued at the moment as in the market capitalization and the share price versus how much money the company might actually make so this line is how much the company will actually earn eventually how much cash is going to come from it how much revenue how much earnings and this line across the bottom is time and this could be any amount of time you could take some companies that have only lasted probably 10 years like i don't know yahoo that lasted about 10 years i think or you could take a company like exxon or at t or tesco companies that have lasted way over 100 years now and we have many different stages of the corporate life cycle this first bit here we call startup or launch that's a period of time where a company makes very low profit very low revenues and the share price doesn't really do much either and this goes on until we hit some sort of catalyst there comes a point where the public start using a technology or start really liking a business kind of like the internet and people start to use it and start paying for it after that we have our exponential growth phase as one or a couple of members of the public start using a product or service everyone else starts to jump on it because it's really good so netflix is a very good example of this and uh google google's a very good example of this everyone as soon as they started getting used to that search engine everyone used it and no one has stopped ever since and that's when a company will see a massive increase in revenue it'll continue all the way up this line and then halfway they'll start to reinvest some money generate new products span out into new areas and the growth will continue to go up when the company reaches a peak it goes into its maturity phase that's when sales slow down competition starts to set in and growth generally slows what happens after that is these companies can start to decay and this happens a lot loads of fortune 500 companies go bust all the time think of smoking drinking and probably eventually oil but many of these big companies do try and start a new phase up they try a reinfest and regrowth phase which i believe is what the top tesla investors think that tesla will continue to do forever and it's between this exponential growth phase and this reinvestment phase which is where i try and target my companies these are the dividend payers that i think will be around forever michelle is a good example of this they're trying to reinvent themselves in the renewable market that's still very much up in the air at the moment whether they can actually do that but there are plenty of companies that have done this apple and microsoft are two companies that continually prove that they can keep doing this and this black line simply represents how much cash a company can generate and how good this company actually is you can't fake this this is fair value and at the moment this red line represents what tesla is doing and i don't think anyone could disagree with this right now the share price has reached 800 billion very very early but actually tesla's full worth is worth much much more than that and i agree with this completely everyone has just jumped the gun a bit and that's okay tesla bears you know the true tesla bears that really don't think tesla's going anywhere they think the share price has done this they think that the share price is now at the maximum amount that the company is ever going to earn so that would mean that the current share price will not grow any further but we know it will we know tesla's price will eventually probably in 10 years be much much higher than it is right now some tesla investors and this is why i really love tesla as a company but i can't invest in it because of the investors that are already in it some tesla investors who probably don't understand investing and probably don't understand business think that the share price will just continue to go up forever they think that it goes consolidation or consolidation up and it doesn't and it won't because that's physically impossible that's the reason why i can't invest in tesla because there's too many people who are invested in tesla right now that think this because we have to discuss what will actually happen to tesla after this and if you're a true tesla bull and you believe that everyone in your tesla bubble all believes the same thing and that they all have the same strong world hands that you do this is what's going to happen to tesla's price at this point all of the big analysts will all jump on and they'll all start saying that tesla is great and the share price will never go down and that should lead to a nice gradual share price rise all the way up until the end so 10 20 years later tesla's share price matches exactly how much money it's going to earn you know if tesla constantly remains at a four year advantage this is how the share price will go that's the dream that's how the tesla balls are planning out but i can't find a case where that has ever actually happened but how do you think it usually goes we have a massive level of what's called exuberance and then everyone just gets bored when the tesla investors who don't quite understand what tesla actually is all start to get bored and their money doesn't go up at 10 20 30 a year they sell and then that in turn makes further investors sell which makes more investors sell which means all that's left is the guys that want to hold and they're the ones that understand what tesla is and that shouldn't bother those tesla investors at all because they know that in 10 years tesla is going to be worth way way more but if you've got that much conviction on tesla you would have bought down here somewhere you would now currently be up 800 to 1000 if you're only up say 400 right now you probably got in too late and believe me i really do hope that it plays out like this i don't think anyone wants to lose any money and i definitely don't want anyone to lose money but right now with everybody being so early to the party and that's what they are they're early to the party companies like square apple paypal crowdstrike roku even zoom maybe they could all still be around for a long long time but right now investors are early to the party and that never goes well because as we've learned from the internet revolution investors in 2000 were really early to the party everyone knew in 2000 that the internet was going to be this next generational thing and it's going to be amazing so they bettered on the big companies that would bring that revolution companies like cisco and i want to show you what happened to cisco over time with its share price in comparison to its earnings and i want to show you that on a website called fast grasp because this is just really really easy to show you this orange line right here is all of cisco's earnings over time down here is the year 2000 where the dot-com bubble burst the cisco didn't have that much in earnings right there but what we can very easily see is that as the internet revolution took off cisco went up in earnings exponentially really did in 2008 during the financial crisis cisco started to top out cisco started to become a proper mature company all the way up today where it's still earning a lot of money so if we add cisco's share price over that time we can start to see the importance of valuation because in 2000 cisco's share price was 65 and after the dot-com bubble like and i and i would say i do think there's an eevee or fintech or just general innovation bubble is that what we're going to call it an innovation bubble i think i'll just say here i do understand the importance of disruptive innovation i think it's very very important but when you push it and market it this hard when you push it so hard off the edge of a cliff you end up in a bubble does anyone get that does anyone agree with me on that i just think that yes disruptive innovation is super important and the next big companies are all going to come from genomics blah blah but if you market it this hard you whip people up into enough of a frenzy you end up with a bubble because people who invest are not smart like you you probably do sit on youtube and look through balance sheets and have a look at the future and you probably understand that tesla's not a car company blah blah blah it's going to have loads of cool things in the future you probably do understand that but do your peers who have invested the same amount of money as you do they believe that do they know that and i would bet that the majority of them do not and they are just chasing the share price we're not a tangent there but let's talk about valuation again so what i'm looking at here with cisco's price is what's called a reversion to the mean now in general over time a company's share price will track its revenue and will track its earnings right here we're looking at earnings i would love to look at revenue because i think revenue is much more important but we'll have to stick with earnings today how heavy is this getting guys is this uh getting a bit too much we've got quite a bit to go cisco's price was all the way up here it came all the way down to 23 which was still above its earnings and then it stayed flat for nine years in nine years cisco's share price made 0.7 now again not saying this is going to happen to tesla we don't know this time it could definitely be different all i'm saying is that throughout history every single company ever has continued to stick along its earnings every company ever ever ever ever and i know some people out there think that tesla is magic but it's still a business okay however if you caught cisco below its value even at 16 right here over time you would see a year-on-year annual return of 6.5 which isn't a lot considering this company went from the best company in the world a company that was going to change absolutely everything it had inventions it was going to spread out into different markets it was going to absolutely crush all of its competition no one could compare to cisco at that time and this is where cisco ended up cisco is still even 20 years on way below its all-time high it's still something to think about tesla might not be like that this time it might be different and i know i've picked out tesla there just because it's the biggest one in the market and it's the most popular stock out there at the moment and i do not believe in any way that tesla is the company that's at the highest risk of a market crash though because this reversion to the mean happens to every company i've got lots of companies myself that are very much at risk of this i've got albemarle that's up 80 i've got ishares global clean energy that's up 130 years been way higher than that i've got kla that's up 50 i've got rio tinto that's up 47 rio tinto probably should not be this high and even walt disney is a good example of a company that could see a mean reversion so this is albemarle i have a very small position in this company and what you can see is that album generally tracks its earnings every time the albemarle gets under the share price starts to go up and goes up with its earnings every time that albemarle's earnings drop we start to see a good few years of underperformance and then we have great news and we have news of lithium prices going up because the ev market is going to start this happened between 2015 and 2017 but because its earnings didn't match it we had a reversion back to the mean and between the years of 2016 and 2019 four years we had a 28 reversion to the mean that means that investors that bought at the top in 2016 lost 28 a year and now pandemic ev stocks youtubers hype we are sending album all back to the moon but albemarle's earnings are not keeping up to it so what's going to happen what do we think is going to happen well in two years you could probably safely estimate based on history that we're going to lose 33 and this is the sort of thing i'm looking at the moment to see whether i should be selling some of my companies microsoft is definitely one that i won't sell i think i did buy it at a premium but i bought it at a good premium i also think this company isn't going to go anywhere for life and it pays some good dividends so i should still even in a market reversion i should still receive some money but even microsoft does the mean reversion over a long period of time between the years of 2000 and 2010 microsoft was minus 2.3 year on year but once microsoft dipped under its valuation we then started to see 20 positive year-on-year returns and now the company's just set off gone to the moon and i'm expecting a meme reversion very soon walt disney is the same story over and over again share price does nothing until the earnings come up then when the earnings start to go up we see a massive rally in price it's just how the stock market works however when good news comes out like disney did with its streaming service things start to change things start to get a little bit weird this is massive overvaluation and if earnings don't pick up pretty soon we'll see the mean reversion that's my prediction anyway and just for giggles this is what tesla's price-to-earnings look like where do we see it going where do we see tesla going where do we get to the point where tesla crosses over with its gains is it down here or is it more across over here i honestly don't know this is just the theory and the learning that i've been doing recently legacy dividend payers like 18t do this too 2000 att did not meet its earnings straight down again earnings start to pick up investors get really happy and the price goes too far the wrong way and we end up with another classic meme reversion but with att right now maybe just maybe we see it in a different way earnings are continuing to rise but the share price is very very low this is because there's a lot of bad news about at t there's a lot of management questions people are worried however when earnings start to recover share prices generally revert to the mean so just based on this information could we think that at t now has a 23 upside within two years possibly i don't know obviously you don't act upon this information just on its own same with tesla you wouldn't just act upon that information on its own if tesla brought out a bomb that killed all other automakers it killed all other battery makers and it killed i don't know mobile eye then yes maybe tesla does deserve its valuation but are we a little bit too early and then we have some companies that do still follow this rule but they always trade at a slight premium like coca-cola coca-cola year 2000 did nothing until 2009. for well-established companies like coca-cola who were just trundling along you might like to follow their normal pe line because again we do see similar mean reversions but they just happen at a premium and coca-cola right now is sitting right on top of its normal pe line coca-cola is again overvalued right now but because it's such a safe company it always trades overvalued maybe this is a positive fundamental case for tesla even apple does not get away with it we see constant mean reversions all the way up its share price every time its earnings take a little slump its share price dumps and now over exuberance hype all in tech stocks people are just flooding into it how long do we seriously believe that this will go on for and i'll tell you this could go on for ages the cisco share price went on from 1995 all the way to the year 2000 five years five years this went on so tesla's share price could now continue could could now continue all the way up for another five years i mean what's that like five thousand percent five thousand percent you could see before it starts to revert and this is what my full problem is i have no problem with elon musk i have no problem with tesla as a company everything the bulls say about tesla is completely true tesla will be worth much more in the future it's an excellent car company it's an excellent not a car company it's going to rule self-driving it's going to probably rule energy but and this is a big but when elon musk decides to tweet out about a messaging app and the completely wrong company goes up five thousand percent that's why i don't want to invest in tesla because we've got too many investors in tesla right now that are attached to the price and they are attached to making quick money that is why i'm not willing to say that it will happen but i'm not willing to take the risk on buying tesla right now and now that i've just done an entire video talking about value talking about fomo and talking about buying things that are way way overvalued i'm going to talk about bitcoin because bitcoin is also something that has definitely not realized its true value yet i'm invested in both bitcoin and ethereal and i'm largely attempting to sort of trade these at the moment ethereum i'm over 100 up i know it says 2.37 but that's because i took a sale to consolidate all my ethereum the other day and bitcoin i kept all separate i only have a very small amount of bitcoin and ethereum compared to my overall net worth bitcoin and ethereum are two commodities where their price is based solely around this stupid human behavior the difference though between these cryptocurrencies and tesla is that in bitcoin people aren't joking themselves about how much tesla or how much bitcoin is worth bitcoin and ethereum prices are solely based on human stupid behavior and the stupid behavior of fear of missing out and for me when this human behavior is isolated in this way it's rather rational and rather predictable so i'm currently in bitcoin and ethereum not because tomorrow i think people are going to start using bitcoin as a currency but because very far in the future i think it probably will be but i'm willing to take the volatility and i'm also willing to make a lot of predictions based on stupid human behavior so i've taken a look at this graph this is the graph of bitcoin after all of the halvings and they all follow a very similar trend they all have a very large ball run they all have a few pullbacks but they all eventually culminate in one very large bear market when you scale all these halvings together they all reach a similar price and this very slim blue line up the middle here is today's price so if we are to look at bitcoin from an anthropological view we might be able to determine that bitcoin still has quite a way to go it still could reach a hundred thousand and to be honest with you that's kind of the area i'm targeting i may take some profit at that point i may even sell but on the other hand i'm a big believer of bitcoin and ethereal so even if this price does tank 90 percent i'm actually very comfortable with sitting on bitcoin for much much longer than this and that's ultimately what we have to think about that's ultimately what this video is all about it's all about risk it's all about accepting that if you buy at such high valuations you might lose all of that money or if you take the case of cisco you might lose all of your money for at least 20 years and as long as you completely understand that risk fill your boots okay i'm just going to finish off with a quick question after me on instagram today uh at life121 says awesomebeard thank you quick question regarding your investing dividends in order to compound interest over time do you reinvest your dividend back into the company that paid it out or do you take a company's dividend payout and reinvest it elsewhere in your portfolio today's been a very good day there's been a lot of dividends paid by trading 212. so i'm going to have a lot of dividend reinvestment happening soon and if you take a normal drip program a drip program often your broker will just reinvest your dividend back into the same company now i don't personally do that specifically because again i'm looking at value i am a big proponent of cost averaging i think that time in the market beats timing the market on all cases however i wouldn't feel as comfortable as investing as much money into kla as i would into say lennar kla is another great example of meme reversion and over exuberance kla's a semiconductor inspection company owns like 80 of its market it's a very very strong company and one of my favorite picks since uh may i think but as you can see tech revolution all the way down to down seven percent a year and now as its earnings have started to increase and it's seeing exponential growth its earnings have gone up quite considerably however again pandemic man pandemic is just smashing this company to the ceiling however if i'm going to look at lennarco i think lenarcorp has a very good couple of years ahead of it it's in the housing sector it builds homes housing inventory in the u.s is very very low and that's my idea around l corp i think it's going to do very very well so i would probably prefer if my dividends from kla did go into something that's got less value at the minute thank you very much for watching guys the investment app that i use is called trading two one two if you wanted to get into investing you can sign up through a link in the description below if you sign up through that link you get a free share that's worth up to 100 pounds also i buy my bitcoin on etoro please remember though that crypto currencies are extremely volatile and your assets are at risk also don't forget to check out the completely free discord um right now we have a new pet section where everyone's putting photos of their dog up um probably nothing to do with investing but this is the sort of community that we're building up now i think it's really cool and obviously that's a separate channel you go into the stocks channel and everyone is banging on about stocks in there there's loads of people who really know their investments we're all talking about trading two on two talking about bitcoin everything like that it's an absolutely brilliant chat room full of information and it's completely free and if you feel like it you can follow me on instagram where i recently showed off my draft thumbnails for my last video with mama fufa her mouth with my eyes and um her eyes with my mouth um absolutely freaky but on the instagram i talk about all the new trades i make every time i buy something every time i sell something if i do and i also post up random stuff about my life thank you again for watching everybody and if you enjoyed this video please feel free to give it a like subscribe onion best you