The Market

I am becoming an ever more reliable indicator. When I become really gloomy and point out the possibility — the possibility — that we may not yet have seen the bottom . . . well, pretty reliably, that means we have seen the bottom. At least temporarily.

My October 13 column was one of those. The NASDAQ had closed the night before at 3074, and on October 13, the day of my column, it jumped to 3316.

The NASDAQ did fall to an intra-day low of 3026 five days later, on the 18th, but it closed out the week at 3483.

That doesn’t mean the market will keep rising, of course, though I have some smart friends who think it will; only that I don’t know where it’s headed.

The day before, I had made fun of some of yesteryear’s high-fliers — companies you may remember with names like Priceline.com, down from 105 to 5. I was crowing about being, finally, right. (Even I get ’em right once in a while.) But then I went out on a limb and let you know that I was short a few shares of Juniper — an astonishingly exciting company (and I mean that without sarcasm), but a company that, at 206, had a market cap over $60 billion. That seemed awfully rich for a still fledgling company.

By the close Friday, it had risen to 232 and added another $8 billion in value — $1 billion a day. (After 22 years, Apple Computer has a market cap of $8 billion. JNPR added this much to its market cap in a week.)

On one of the financial-chat message boards, the analysis was that JNPR would easily run to 300 on anticipation of the next split, then to 400 on panicked short covering (mine!), and then to 500 upon inclusion in the S&P 500, when all the index funds would have to buy it from the still more terrified shorts. That would mean nearly an extra $100 billion in market value for the company based on . . . well, nothing.

“Nothing,” because a split adds no fundamental value to a company. Short-covering adds no fundamental value. Inclusion in the S&P adds no fundamental value. But, this message-poster argued, these three factors could drive Juniper’s market cap up another $100 billion, which is more than the value of all the gold in Fort Knox. (Interested in gold? Read Peter Bernstein’s wonderful new book.) And he may be right!

To show me how old-fashioned I have become, my good friend Joe Cherner (who also thinks some of today’s valuations are bonkers) posed this challenge: “See if you can rank the market cap of these four companies in the correct order.”

The four companies he selected:

SUNW — Sun Microsystems
IBM — it makes computers and stuff
EMC — memory storage
VOD — Vodaphone — mobile phones

Go ahead. Give it a try.

Can you do it?

Seriously — give it a shot!

Don’t cheat! (I didn’t cheat, but I didn’t get it right, either.)

I have to keep writing these short paragraphs so that the answer is down below the bottom of your screen and out of sight.

Have you tried it?

Are you pretty sure you’re at least close to being right?

Have you written down your ranking?

Is it your final ranking?

Well, as of Friday night, these four companies stacked up this way:

Interesting, no? Poor little IBM.

Poor little Xerox, meanwhile, once one of the most valuable companies in the world because of its exciting near-monopoly technology, was valued at not quite $6 billion Friday, selling at a price/earnings ratio around 11. And Polaroid? Back in 1972 it was one of the Nifty Fifty with a fabulous price-earnings ratio. Today, the market values Krispy Kreme — the donut people — at twice as much.

So what’s a company worth?

In theory, a company is worth the sum of all the future dividends it will ever pay, plus some eventual final pay-out if it is ever acquired or liquidated — all discounted back to today’s dollars. (You “discount” the value of those future payments because a $2 dividend check 20 years from now is not something you’d pay $2 for today. If you demand an 8% return on your money — if that’s the number you set as your discount rate — then you should be willing to pay 43 cents today for a 20-year-distant $2 dividend check. Or so sayeth the Present Value key on my pocket calculator.)

But companies don’t pay a lot of dividends any more — certainly not the four ranked above (IBM will toss you half a dollar every year and Vodaphone, a quarter, but that’s it for now) and it’s hard to imagine companies of this size being acquired, let alone for cash.

So you value companies of this type as best you can based on your guess as to future earnings and the price those earnings will command . . . or based on your guess as to when the stock will split, when the shorts will panic, and when the company will be added to the S&P 500 Index.

When you think about it, it’s a marvel of abstraction. Money itself is based on nothing more than trust. No longer backed by gold, dollars are just paper. And not even paper, for the most part — electronic blips that make the balance in your account go up or down.

You then take this money to buy shares in enterprises that you’d just as soon paid you no dividends, hoping, instead, that the share prices of the enterprises will increase as the enterprises grow.

Amazon may finally begin to make money, now that prices have risen sharply — I’m almost as happy ordering from Amazon at 20% off as I was at 50% off. But then again, it may still not make a profit, let alone pay a dividend. Things may work out well, but it’s conceivable that this company, which went from zero to a $40 billion market cap, might never make a profit. Or might never pay an appreciable dividend if it does make a profit. Can huge fortunes be rationally made owning shares in companies that never make a profit? Ultimately, no. But along the way? Big-time.

Might the EMCs of the world prosper magnificently for a while but eventually just sort of peter out, as Xerox and Polaroid seem possibly to be doing? Might they never pay out a dime before being rendered obsolete 20 or 30 years from now? (Xerox and Polaroid have paid dividends for a long time, but probably not enough to have justified their 1972 stock prices. Today’s high-tech companies might pay even less in the way of dividends, because, at least for now, the market doesn’t much care about them.)

It is on this cashless and in some cases profitless foundation that huge fortunes are built. May it remain ever thus.

Still, I’d pay off my car loan and credit card balances before I plunged into the New Economy to build a fortune of my own.