When Fundamentals Went Out The window And Momentum Was All That Mattered

Was reading some OLD investing articles.

Here's a real fun one from way back 2004.

Sorry I have lost the link to the article.

• Value holdouts give in
  
  MATHEW INGRAM
  Thursday, January 22, 2004
  
  One by one, they are falling -- the tech-stock valuation holdouts, that is. For a time, there were a few analysts who stuck with the old-fashioned concept of "fundamental value." They refused to hand out "buy" ratings to high-flying tech stocks such as eBay and Yahoo -- and, lately, even Nortel -- when they were already selling at astronomical multiples. But their resolve is fading in the face of a buying frenzy.
  
  On Wednesday, Legg Mason analyst Thomas Underwood threw in the towel on eBay, which his brokerage firm has rated a "hold" for some time as result of the stock's nosebleed share price. "Historically, we have been overly concerned about eBay's valuation," he wrote, "and we've historically been wrong by not recommending purchase." In other words, the stock has just kept right on going on up, despite the fact that it is arguably overvalued. And a brokerage firm can't go on ignoring that kind of thing forever -- clients like to make money, the fundamentals be damned.
  
  The same day, TD Newcrest analyst Mark Lucey did pretty much the same thing on Nortel. "When valuation matters, it will matter a lot. But for the time being it is a secondary consideration for the market," he wrote, upgrading Nortel to a "hold" from a "reduce" rating. He added that he was "facing up to the fact that despite having generally called the telecom equipment industry's improving outlook correctly, we have got its valuation wrong so far in 2004."
  
  As Mr. Lucey put it, the market has "moved into odds setting mode," and is trying to pick winners and losers rather than worrying about fundamental value. This is "not necessarily irrational," he says, but rather a "natural outcome of the market's struggle to discount an uncertain yet improving future." As it stands, Mr. Lucey says, the "anticipation of positive earnings momentum is all that matters."
  
  Just a few weeks ago, George Notter of Deutsche Bank said that he felt "sheepish about upgrading [Nortel] on top of its recent run," which at that point had taken it to about the $6 (U.S.) range. But he did so nevertheless, and managed to come up with a 12-month target of $6.85 -- by saying he felt the stock was worth 38 times what Nortel was likely to make in 2005.
  
  One of the first to lead the charge toward dispensing with valuation -- at least as far as Nortel is concerned -- was RBC Capital analyst John Wilson last September, when Nortel was trading at $4.50 (30 per cent below where it is now). He entitled his report "Stop Pulling Your Hair Out... Maybe Valuation Just Doesn't Matter." In it, he argued that Nortel's stock was bound to go up as its revenue increased, regardless of whether the price seemed rational based on normal valuation methods.
  
  In effect, Mr. Wilson said, the healthier Nortel was perceived to be by the marketplace, the more investors would be willing to pay for the same earnings per share, thus expanding the EPS multiple and pushing the stock higher. So as Nortel has signed contracts (of uncertain value) with carriers such as Verizon, optimism has increased, and instead of trading at 10 or 15 times its projected profit per share, the stock is now 30 or 40 times. Is that justified? Perhaps not, but it's happening.
  
  When it comes to eBay, Thomas Underwood of Legg Mason tried to justify his reversal on the stock by pointing out that eBay "now trades at a discount to both Amazon and Yahoo on 2004 EPS (earnings per share) multiples despite having a higher predicted growth rate and a more consistent historical performance." In other words, eBay still isn't as overvalued as Yahoo and Amazon, therefore it's a buy.
  
  So eBay only trades for about 100 times its profit in the past 12 months, and about 60 times its projected earnings for next year, while Yahoo sells for 130 times its profit over the last 12 months and 63 times its estimated profit for 2005. Amazon is also trading at about 63 times its projected profit for 2005. Makes eBay sound like a real bargain, doesn't it? Nortel, incidentally, isn't that far below these tech heavyweights, since its stock is trading at about 50 times consensus profit targets for this year.
  
  To Mr. Lucey's credit, he makes a point of saying that "despite the merits of staying with the upward momentum of the sector, it would be foolish to ignore valuation altogether." It will matter again at some point, he argues, and therefore investors should try and get a grip on it now -- by trying to figure out what the real earning power of a company such as Nortel is in a healthy telecom market -- in order to be prepared for when valuation suddenly matters again.
  
  And when will that be? No one really knows. Investors were supposed to have learned their lesson during the last tech boom, when fundamentals went out the window and momentum was all that mattered -- and industry leaders such as Amazon, eBay and Nortel traded at astronomical multiples of estimated future profit. Instead, they seem determined to repeat the process all over again. Whether it will end the same way remains to be seen.