Editor’s note: This article was first published in April 2014; the WhatsApp deal, the analyst price target for Facebook and the market conditions it discusses are from that time. The anticipated burst did not come in the following years: the Nasdaq Composite rose from roughly 4,000 points to nearly 9,000 by late 2019.
The founder of Greenlight Capital, David Einhorn, has sent a clear message in his letter to investors, stating that “we are witnessing our second tech bubble in 15 years”. He admits, however, that he doesn’t know how long it may take to burst. In the stock market you sometimes know that something is going to happen, but it is very hard to know exactly when.
Einhorn also acknowledges that even some companies trading at a P/E of 20, 50 or 100 (100 times their earnings) may have genuine growth prospects. Very ambitious expectations, but still within the bounds of normal.
He says the current bubble is a replica of the previous one, although with fewer large-cap stocks involved, and with retail investors keeping somewhat more distance from those stocks because of their memories of the dot-com bubble.
The features that Einhorn sees as echoing the previous bubble are, first, the rejection of conventional methods for valuing companies: investing in companies with a P/E above 500 now seems normal, when in normal circumstances it would be sheer madness. Second, short sellers’ attempts to make money by betting on what would be logical (a correction that puts prices back where they belong) have ended up costing them money. They have had to close their short positions to stop their losses from growing (which pushes prices even higher), or else hedge their short portfolios, something that is normally done the other way round.
Facebook’s latest acquisitions can also be read in two ways. On the one hand, buying WhatsApp for $16 billion sounds like madness that shows how astronomical valuations have become; at the same time, it could reflect Facebook’s expectations of generating more profit.
Like other investors, myself included, Einhorn is not asking whether there is a bubble or not, but how much further the high valuations will go and when the bubble will burst.
Recently, some research firms have given Facebook a price target of $85.
See also: David Einhorn: 5 stock market lessons I learned from poker
