WeWork, the shared-workspace startup, was valued at $47 billion at the start of 2019. That’s more than the market caps of a number of S&P 500 companies, such as Ford Motor Co. (F) at $36 billion, Twitter Inc. (TWTR) and Advanced Micro Devices Inc. (AMD) at $40 billion, to name a few. But after scrapping a planned initial public offering (IPO) and getting bailed out by one of its major investors, SoftBank Group Corp., the tech unicorn was recently valued at just $8 billion. Almost $40 billion just disappeared.
The whole debacle offers investors a cautionary tale of what can happen in an environment of easy money where a company’s revenue growth is all that matters and profitability is something that can be put off until another day. But the days of easy-money financing may be coming to an end, and the WeWork fiasco, if nothing else, may have something to teach investors about value, according to a recent column in The Wall Street Journal by James Mackintosh.
- WeWork not the only firm to ignore losses while chasing profit.
- Investors could see even bigger losses from recent IPOs losing money.
- Higher bond yields will favor value stocks over growth stocks.
- Investors will care more about present earnings and cash flow.
- Recent turn to value stocks could reverse if trade war escalates.
What It Means for Investors
The first lesson is that what happened to WeWork can also happen to other high-profile unicorns. Ignoring losses while chasing growth was not unique to the company. Such a business model was and is characteristic of Uber Technologies Inc. (UBER), Lyft Inc. (LYFT) and Pinterest Inc. (PINS), this year’s three most-valuable IPOs. All three predicted losses for at least three years while chasing sales growth of a forecasted 30% a year. All of them are now trading well below their public market debuts.
The second lesson is that investors may see even bigger losses as just 25% of this year’s IPOs are expected to post positive net income during their first year. That’s the lowest since the bursting of the dotcom bubble in 2000. Further, just 8% of technology, media and telecom companies hitting public markets last year were profitable during their first year of business, the lowest level going all the way back to 1995, according to the Journal.
If that’s not enough to make investors sick of growth stocks, the third lesson says bond yields have picked up in recent months, and while that’s a boon for value, it’s more bad news for growth. Higher bond yields suggest the economic outlook may be improving, and that bodes well for cyclical stocks that had fallen out of favor but now look like bargains. Also, higher bond yields imply higher discount rates, making future earnings worth less compared to present earnings. Since growth stocks are all based on future earnings, they look less attractive.
The WeWork meltdown amid rising bond yields prefigure lesson four: investors will be much more fixated on companies’ present earnings and cash flow picture, and less concerned about sales growth. It’s already happening as a number of highly valued growth companies recently reported better-than-expected revenue only to see their shares tumble on lackluster earnings. Tesla Inc. (TSLA), on the other hand, reported worse revenue than forecast but an unexpected profit—its shares soared. The bottom line is back in vogue and that means value investing is also back in vogue, at least for now.
Lesson five is a bit of a rejoinder to lesson four. That is, value is back so long as value actually performs. In other words, a cheap stock is one whose price is low relative to its company’s earnings. Earnings need to be robust, something that could be difficult if U.S.–China trade tensions worsen. There is a lot of optimism that the world’s two biggest economies are making progress on settling their differences, but if the trade war escalates and the global economy falters, value stocks will surely take another hit.
But the lesson of WeWork is that growth stocks are not necessarily the best alternative when value looks unattractive. Investors who have learned that lesson may be more reluctant to pile into growth this time around. At the very least, investors are going to have to be a little more diligent and choosy about where they decide to stash their cash.