John Dorfman: The near insanity of investing at 100 times revenue
The height of folly.
That’s what I call it when people pay 100 times a company’s pre-share revenue to buy a stock. You see this behavior mostly with young biotechnology stocks and fledgling technology stocks.
Investors mentally build what economics professor Burton Malkiel called “castles in the sky” when they drool over the potential in these stocks.
Of course, it’s possible to luck out if you catch the “next NVidia” but the odds are strongly against you.
Over the years, beginning in 2000, I’ve written 14 columns warning against investing in these sky-high stocks. The stocks I warned against have lost money 11 times out of 14, and have lagged behind the Standard & Poor’s 500 Index 12 times.
The average 12-month loss on these stocks has been 32.4 percent, while the Standard & Poor’s 500 has averaged an 8.9 percent gain. Figures are total returns including dividends.
Of the 67 stocks I’ve focused on, each selling for 100 times revenue or more, 51 have fallen and only 16 have gained. And half the gainers still trailed behind the S&P.
Bear in mind that my column recommendations are theoretical and don’t reflect actual trades, trading costs or taxes. Their results shouldn’t be confused with the performance of portfolios I manage for clients. And past performance doesn’t predict future results.
Last year’s results were in keeping with the historical pattern. I warned against investing in Alnyam Pharmaceuticals Inc. (ALNY), Bluebird Bio Inc. (BLUE) and Adamas Pharmaceuticals Inc. (ADMS). They fell 32 percent, 36 percent and 69 percent respectively.
The average loss was 45.5 percent, while the S&P 500 gained 3.6 percent.
Maybe one of these companies someday will come up with a cure for cancer or Alzheimer’s disease. But as with car companies a century ago, or radio companies a half-century ago, there are many entrants, and most will end up in the dust.
Now, here are three new companies where investors’ hopes are running high, to the tune of 100 times revenue or more.
Denali Therapeutics Inc. (DNLI), based in South San Francisco, Calif., is a biotechnology company working on medications for neurological diseases such as Alzheimer’s. Analysts estimate revenue at about $30 million last year, $37 million this year and $110 million next year.
Nice growth. Problem is, investors already value the company at almost $2 billion. The stock price is 556 times recent revenue and about 19 times the revenue analysts expect in 2020.
By comparison, the average stock today sells for 2.1 times revenue, and over the years the average price/revenue multiple has been about 1.4.
Seven analysts cover Denali, and three of them — including the ones from J.P. Morgan and Morgan Stanley — call it a “buy.” I am with the skeptics, as I’ve seen many promising medications fail to achieve regulatory approval and market success.
Tellurian Inc. (TELL) of Houston, Texas, liquifies natural gas, making it possible to ship the gas long distances by container rather than by pipeline.
Analysts figure that Tellurian will probably do about $124 million in sales this year, up from only about $10 million last year. For 2020, they project about $286 million in sales.
That’s exciting, but maybe investors should contain their enthusiasm a bit. The company is expected to lose between 50 and 60 cents per share this year and next. The current market value of $2.48 billion is 157 times revenue.
Part of investors’ excitement about Tellurian is based on plans for India to import a lot of natural gas. Prime Minister Narendra Modi has set a goal that India should get about 15 percent of its energy in a few years, up from 6.5 percent now.
I feel that Modi has many good ideas, but he hasn’t necessarily been able to implement them.
Based in Morris Plains, N.J., Immunomedics Inc. (IMMU) makes products to detect and treat cancer. Sales this year are expected to run about $60 million. The stock market values the company at $2.7 billion.
Immunomedics has been public since 1983, and the stock traded above $20 a share in 2000 and 2001. It spent most of the time since then in single-digit territory, but is quoted now a little above $14.
Analysts and traders are excited about the company’s pipeline, which consists largely of monoclonal antibody treatments for lupus and various forms of cancer. I hope the drugs pan out as hoped, but I think the stock is hopelessly ahead of itself.
Disclosure: A partnership I manage has a short position in Alnylam Pharmaceuticals and would profit if Alnylam declines.
John Dorfman is chairman of Dorfman Value Investments LLC in Newton Upper Falls, Mass., and a syndicated columnist. His firm or clients may own or trade securities discussed in this column. He can be reached via email.