By Saku PanditharatneThe Covid-19 pandemic may have hurt the economy, but for technology stocks it feels like 1999 again. The Nasdaq Composite Index just reached a record high having rebounded about 50% from its low of the year in March. The stock market is not the economy, but it does feel strange for stocks to be soaring in the middle of a deep recession.

The difference is timescale: stock prices represent revenue and earnings very far out into the future, not today. If plans for new technology are sound, the outlook can still look bright even though the present seems gloomy. The rationale for sky-high valuations for tech stocks in the late 1990s also came from projected profits in the decades to come. These so-called concept stocks won investors through a compelling story about future potential, even though the company in the near term would generate little-to-nothing in terms of real revenue.

Maybe concept stocks were a crazy phenomenon from a more exuberant time, such as Beanie Babies or jelly shoes. But take Tesla Inc. True fans are buying the stock because they believe in a vision of a technologically advanced electric car and other products, while grouchy short-sellers write long, critical blog posts about the companys weak balance sheet and high debt. Is it better to price the stock on the concept, or on the fundamentals alone? Neither seems like the perfectly accurate way to value the company.

Valuations that are too high can lead to vaporware and waste, but a valuation that is too low can become a self-fulfilling prophecy. In other words, if Tesla were valued only on its balance sheet, the company might not be able to raise enough cash to keep building and developing electric cars. It seems a fairly safe bet that Tesla is innovative enough to keep coming up with new inventions, above and beyond their existing revenue lines, but when new products are involved, the expected future profit and revenue over the long term is difficult to predict.

Many people would put a high probability on Apple Inc. coming out with a new product, such as virtual reality glasses, but the companys shares were trading at around a relatively paltry 20 times earnings through much of 2019, which amounted to not much more than future iPhone revenue. Although the ratio has moved up to about 30, that still seems low for a company like Apple and may be a sign investors are shifting away from valuing it just on iPhone revenue. Experienced venture capitalists are happy to take the risk on hypothetical products for early-stage startups, but the stock market hasnt figured out how to price in products that are yet to be created by established public companies.

To be sure, the difficulty of pricing in new product lines does exist in the realm of private companies. Softbank Group Corps Vision Fund made big and bold bets in promising companies, valuing them above what their revenue might suggest. But some of these companies were not able to meet their targets, collapsing under the weight of too much capital. For growing tech unicorns, valued in the $1 billion to $50 billion range, it is certainly difficult to raise money for a new product line based on intangible assets. Capital should be flowing into these highly innovative, cutting-edge companies in the current low-interest rate world, but few understand how to structure the appropriate financing.

With an economy in trouble, the path back to prosperity depends on tech companies rapidly scaling up, generating revenue and creating jobs. Finer-tuned pricing of intangible assets could speed up the recovery process, allowing growing tech companies to raise money for new product lines, rather than just to scale up old ones. It could also help them to acquire old economy companies in leveraged deals financed around symbiotic revenue benefits.

In some ways, intangible capital is reminiscent of the nascent days of high-yield bonds in the 1980s, in that an accurate formula could change the world. Price it correctly, and you would be able to leverage small amounts of capital to totally reshape the economy instead of promoting breakups and hostile takeovers. So instead of criticizing high stock prices for tech companies, embrace and understand them for they may be the key to the economic recovery. The race is on to figure out the winning formula.

Originally posted here:

Instead of criticizing valuations of Tesla & Apple, embrace them - Economic Times