Bubbles are a regrettable part of financial markets and like the other cycles that are part of their ebb and flow they inevitably form periodically. Investors who get caught up in a ‘bubble’ can potentially lose significant amounts of money when it eventually bursts. Particularly if they’ve jumped on the bandwagon at an advanced stage.
A ‘bubble’ refers to the phenomenon of a particular asset’s price rising by a huge amount over a relatively short space of time. Crucially, in a bubble, the extent of the price rise is fuelled by hype rather than any tangible factor that changes the short to medium term financial fundamentals that value would ordinarily be, even if not tightly, tied to. Added to hype is a ‘fear of missing out’. As the price rockets on hype it gathers more pace as more investors pile in, afraid that they have failed to take advantage of huge gains earlier and determined not to miss out entirely. This creates a snowball effect, blowing the bubble up further.
Bubbles usually build because of enthusiasm for the long term prospects of the asset whose price is rising. However, they fail to take into consideration all of the variables that could change in the meanwhile and mean the extent of enthusiasm isn’t realised. This risk would ordinarily be priced into an asset’s market value, putting some kind of a lid on price.
Behind most bubbles there is good reason for investor enthusiasm – the dotcom bubble being a perfect example. The online and digital economy went from strength to strength after the bursting of the dotcom bubble, despite the fact that many weaker companies that lacked real business foundation beyond the hype were wiped out.
Investors who bought into the bubble lost a lot of money but there was a basic underlying reason for enthusiasm around online business models. It was just that investors lost sight of the fact that not every online business would necessarily be successful. Or successful enough to justify giddy valuations. There would be competition between them as well as with traditional offline businesses in the same sector and only those with strong products, services and business models would prosper. Which many eventually did once the wreckage of the wider stock market crash caused by the bubble bursting was cleared.
In 2017 Bitcoin and the wider cryptocurrency market became a bubble. Bitcoin’s price rose from $1000 in January to $20,000 by December of the same year, taking most of the other major cryptocurrencies like Ethereum and Ripple along for the ride. When it finally burst Bitcoin’s price slid back down towards $4000. If price rises had stopped at $4000 initially that would still have been huge growth – 400% – and a sign of the potential of cryptocurrencies and blockchain technology. And cryptocurrencies are rising again, Facebook have even announced it will launch a digital currency next year. But the extent of the 2000% gains were a classic bubble. The market got far ahead of itself even if long term enthusiasm had some justification.
Many now believe the stock price of Beyond Meat is displaying all of the hallmarks of a classic bubble.
Since its post-IPO market debut on May 3rd, the share price of Beyond Meat, the Californian plant-based faux meat company, has risen to a spectacular extent. The company priced its IPO at a reasonable, given the company’s still comparatively modest turnover and the fact it is still loss-making, $25 a share. Demand was high enough to mean that was the top of the $23-$25 range targeted but now looks an absolute bargain.
Over the now approaching 7 weeks since the shares went public on Wall Street’s Nasdaq exchange, they have risen to the extent that the IPO will go down as the most successful in history. At least in terms of its early gains after shares started trading. Beyond Meat’s stock is now trading at just shy of $170. That represents a phenomenal 646% gain on their starting value.
However, the extent of those gains is now raising concern in some quarters. A number of professional stock market analysts and investors have started to call ‘bubble’. A financial markets bubble usually forms when large numbers of inexperienced investors follow hype and buy into an asset without fully understanding the fundamentals behind how similar assets are usually valued. Bubbles are fuelled by enthusiasm that ignores what would normally be considered ‘fair value’ metrics and instead focus on a theoretical future that justifies the hype, ignoring the myriad of factors that pose a risk to that theoretical future actually transpiring.
Beyond Meat’s products and image tie perfectly into the growing school of thought, particularly prevalent among educated millennials with the disposable income to buy shares, that ‘big agriculture’ meat farming is both one of the biggest emitters of polluting gases and is inhumane. The company’s host of celebrity ambassadors, including U.S. ski champion Lindsay Vonn and former NBA star Shaquille O’Neal, have further raised its profile, as have high profile investors such as actor Leonardo DiCaprio and the rapper Snoop Dog.
The throngs of small retail investors that have poured into the Beyond Meat stock in recent weeks undoubtedly have the best of intentions – supporting an ethical and environmentally responsible product, and financially supporting the business behind it to further expansion. However, there is more doubt about whether they understand the long term viability of an investment at current prices.
Beyond Meat’s current market capitalisation of over $10 billion means the company is trading at nearly 50 times its projected forward revenues. By all normal metrics the stock’s market valuation is now completely unmoored from the company’s financials. That’s been driven by amateur investors, not the professionals, who have long ago stopped buying. Those lucky enough to buy early will be rubbing their hands in glee at the paper returns being driven by the inexperienced enthusiasts. They’ll also be fretting over when to sell and realise their current paper profit. Many will already have sold out or down, delighted to have made whopping return well into the triple figures over a matter of weeks and not be trying to time the bubble’s peak.
At this point it is hard to argue the Beyond Meat stock is not deep into bubble territory. The company certainly has big potential. Barclays analysts believe that alternative meat products could capture as much as 10% of the global $1.4 trillion annual meat market by 2029. But Beyond Meat won’t have that market to itself. It already has competition, the biggest of whom is the still private but very well-funded Impossible Foods. Yes, Beyond Meat is setting the pace in a new and quickly growing market but it’s current share price prices in the kind of market dominance it is impossible to know if it will achieve. The odds say it won’t.
The share price is now, on the basis of any traditional valuation metrics, completely detached from the fundamentals of what is essentially still a relatively small company in a still nascent market. It seems that a crash from current levels is almost inevitable and the only question is when and how that will transpire. That doesn’t mean Beyond Meat won’t go on to be a very successful company. But the worry is millions of well-meaning millennial investors, many of them dipping their toes into the stock market for the first time, will be burned badly when Beyond Meat’s stock price does return to a level somewhere in the vicinity of ‘normal’.
There are echoes of a recent and similar runaway share price rise – that of legal cannabis stock Tilray. In 2017, when Canada announced that it would legalise cannabis in 2018, both for recreational and medical, use the company’s share price gained 1665% in less than three months. The legal cannabis market will almost certainly grow massively over the next years and even decades.
But the Tilray share price rise had nothing to do with the actual revenues or profits of the company, or even their rate of growth. Tilray is not the legal cannabis market but one company in it. There was and is no guarantee that 10 years from now Tilray will dominate that market. As is usually the case, the Tilray bubble was fuelled by hype and hundreds of thousands of inexperienced amateur investors jumping onto the bandwagon.
How To Avoid A Bubble?
In theory, avoiding getting burnt by a bubble isn’t difficult. The tricky part is an investor detaching themselves from emotions such as fear of missing out, greed and excitement. But viewed objectively, bubbles are easy enough to spot. Look for these tell-tale signs:
1) Price rises are much faster and steeper than norms.
2) Investor confidence is based on a bigger, long term market picture but being focused on one asset or company and assigning it short term value that reflects the long term belief in the whole market.
3) Value is being assigned to an asset with little significant having actually changed in the financial fundamentals that underpin that asset.
4) If the asset is a commodity, demand is being driven much more by investors than the end users of the commodity.
5) A majority of investors driving price rises are inexperienced, amateur investors.