This Tech Bubble CEO's Warning Resurfaces After Nvidia's Blockbuster Earnings — 'What Were You Thinking?

In hindsight, financial bubbles seem obvious. For investors looking to find parallels between today's stock market and other points in history, some have made concerning comparisons to the dot-com bubble, in which the Nasdaq Stock Market fell by 75% in just over 2½ years.

Even J.P. Morgan Chase & Co. JPM strategists have flagged some similarities to the era. A recent note by analyst Khuram Chaudhry said, "Parallels to the ‘Dotcom Bubble' era are often dismissed due to the ‘irrational exuberance' that characterized this period. In this note, we demonstrate that there are a plethora of similarities between these two periods."

At the time, valuations were extreme but justified by the market given a then-expected surge in future demand caused by the internet boom.

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Sun Microsystems Inc. was a poster child of the dot-com era, reaching as high as $250 per share only to fall back to $10 per share near the end of 2002.

Sun Co-Founder and CEO Scott McNealy told Bloomberg around that time that it was obvious his company was ridiculously overvalued. 

"Two years ago, we were selling at 10 times revenues when we were at $64. At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends," he said. "That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D [research and development] for the next 10 years, I can maintain the current revenue run rate. 

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"Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don't need any transparency. You don't need any footnotes. What were you thinking?"

McNealy explained how challenging it is to live up to lofty market expectations, especially when a high price to sales is used by analysts to value stock prices.

The price-to-sales metric continues to be used and explains how much investors are willing to pay for $1 of a company's sales. 

While McNealy explains why a 10 times price-to-sales is high, investors have had no problem bidding up Nvidia Corp.'s NVDA stock price, giving them a 32.27 price-to-sales ratio.

Investors scared off by a lofty price-to-sales metric would have missed out on a massive gain in Nvidia's stock, which is up around 235% in the past year and close to 2,000% over the past five years, even though its price-to-sales has been higher in the past than it is today.

In July 2023, for example, its price-to-sales ratio was as high as 45.8 and even ended 2021 over 30, well before the artificial intelligence (AI) boom started.

This goes to show that companies can live up to their high expectations but are required to maintain and increase their incredibly fast growth just to keep their stock prices at today's levels and allow for future appreciation.

Any companies looking to compete with Nvidia will be working to eat into their margins and gain market share, meaning investors buying and holding Nvidia today better hope they can maintain their dominant position for years to come.

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