By Monish Chhabra ǀ April 20, 2019

For any company, its stock price grows largely in line with its underlying business over time.

One way to measure the growth of the business is through its ‘sales’. Comparing it to the rise in its share price, can indicate if the market price is running ahead of the business fundamentals, lagging it, or keeping pace.

We use this assessment for a large technology company, that has been around since before the dot-com boom of the late 1990s, and has been recently considered by some to be in a bubble again now. This company is a major online supplier to consumers and businesses.

The following graph shows the growth in its sales (blue line), and the growth in its share price (orange line), over the last 23 years.

From 1997 to 1999, the sales of this business grew extremely fast; 15-times in just 3 years. However, the stock price grew even faster; 31-times in the same 3 years.

This happened despite the fact that the stock was already priced at 8-times sales at the beginning of this run up. By the end of the rally, the price was 30-times sales.

This was clearly a bubble; share price had run much further than the underlying growth of the business. Also, the stock was implying future growth in sales at a rate that was unprecedented and unsustainable.

From 2000 to 2001, the dot-com bubble burst, and the stock price fell really hard. It bottomed at a multiple of 2-times sales.

Just like there was too much enthusiasm on the upside earlier, there was probably too much pessimism on the downside now. The stock bounced back, and soon settled around 2.5-times sales.

Since then, the two lines have largely moved in pace with each other. Indeed, the stock price has been more volatile than the underlying business, especially around such events like the market crash of 2008.

However, by and large, the slope of the orange line (i.e. the rise in the stock price) has been roughly similar to the slope of the blue line (i.e. the growth in the underlying business).

As of today, the gap between the two lines is slightly narrower than usual. The stock is trading at 3-times sales. However, it doesn’t bear any resemblance to 1998-1999 period. This is no second coming of the dot-com bubble…at least not yet.

There might be some chatter of over-pricing in some tech IPOs, or in certain private deals. However, for many large established companies, the strong run up in their stock prices has largely matched the strong growth in their business. This is pretty much how it should be.

If there is a tech bubble that is going to burst, it would have to start first.