Okay. All the feel-good moments are over.
We’ve gotten our fresh start with a new president. The calendar has turned from an anguishing year. The stay-at-home plays, pandemic-accelerated technologies and promise of emerging digital entertainment such as mobile sports betting have driven the stock market to record highs.
Now it’s time for reality.
Reality might mean the stock market’s bull run continues unabated, but I don’t think so. As the late Barron’s magazine columnist Alan Abelson often wrote, “Trees do not grow to the sky.”
There are numerous reasons the bull might transform into a bear. They include the fear and effects of higher taxes. The fear and effects of wild deficit spending. The fear those deficits will feed the long-dormant beast of inflation.
But more immediately, and perhaps more likely, the stock market will go into a correction. And it can happen at any moment. All it takes is a dawning realization on the part of enough investors that stimulus or no stimulus, millions of people are out of work. Or that stocks that have run up 1,000 or 2,000 or 3,000 percent aren’t going to repeat those gains, so where do we go from there? Or a sharp setback that isn’t immediately offset by positive vaccine news. Or another government spending bill. Or another pronouncement by Jerome Powell that the Fed can and will come to the rescue.
Here’s a case to consider. Tesla earnings forecasts are lower today than they were two years ago, yet the stock has risen seventeen-fold, from around $50 to nearly $850.
Let’s look at gaming. Online sports betting and iGaming are the rage. Some stocks are selling at 30 times and 40 times future revenues that might not be realized. In one case, we’ve seen digital gaming valued at 60 times future EBITDA. Can any operation be fairly valued at 60 times yet-to-be-achieved EBITDA?
It’s become common to liken the current era to that of the 1990s, when gaming proliferated throughout the great river valleys of the Midwest and Mid-South. That era also excited investors. Reports of people standing in long lines to pay for the privilege of entering casinos in order to lose their money to the riverboat owners caught the imagination—and the capital—of investors.
Many stocks shot up to astronomical levels. Then they collapsed. The reality set in that revenue doesn’t necessarily convert into profit, especially for companies floated primarily by junk-bond debt. But that brought opportunity. Big companies like Harrah’s bought up the small fry. Small companies like Penn National grew into nationwide casino operators.
The point is, even a revolutionary expansion of the gaming industry didn’t mean that crazy valuations were sane or that all operators would survive.
Likewise today. The emergence of digital gaming in the U.S. is revolutionary. Projections of $15 billion or $30 billion or $50 billion of annual revenue may prove true. And there will be winners. It’s the job of investors not only to identify the winners, but also calculate whether a winning company is a winning stock, as there’s such a thing as too high a price.
One place to look is cost of player acquisition. It may be to digital operators what the high cost of debt was to riverboat operators, who didn’t make it despite booming revenues.
So, enjoy the record market ride and scarf up the SPACs. But don’t forget Alan Abelson’s caution: “Trees do not grow to the sky.”
