In the 17th Century Netherlands there was a market mania for tulip bulbs. Some rare and unique tulip bulbs were said to have traded for the value of a house or plot of land. And while scholars dispute the extent of the market mania, it is clear that for a period, tulips were trading at an extremely high valuation.
What makes a price too high to pay? People were willing to pay so much for a tulip, yet it seems unreasonable that a tulip would ever be worth that amount. It is likely that tulip buyers at the time also considered these values extremely high, but that many of them believed that they would be able to sell the bulbs for a higher price regardless.
In many ways there are parallels between this situation and what we are seeing now in a lot of ASX listed technology stocks, particularly buy-now pay-later (BNPL) stocks. Plenty of investors will tell you that these stocks is extremely expensive and the majority are not buying the stock because they are expecting decades of high and continuous growth in the underlying business. Instead, many of them are invested in the belief that they will be able to shortly sell the stock to someone for a higher price than they paid.
This is a perfectly valid strategy. Plenty of the early adopters of things like Bitcoin harboured not the view that Bitcoin would be useful in future, rather that they could shortly sell the coin to someone for a greater price. This is what a lot of short-term trading revolves around, there is less consideration for the long-term fundamentals underlying an investment and more consideration for short-term price momentum.
Short term trading is fine, but eventually the longer-term fundamentals do matter to a longer-term investment. As the adage goes, ‘in the short-term markets are a voting machine, and in the long-term they are a weighing machine’.
In the seventeenth century Netherlands, the supply and demand dynamic shifted. Too many bulbs were coming on to the market and not enough buyers we willing to pay higher and higher prices. As a result, the supply-demand dynamic shifted, and prices crashed.
These problems experienced by tulip prices can highlight some of the issues of investing in extremely high valuation speculative stocks. While you may argue that there are far greater fundamentals underpinning the Buy-now-pay-later market for example, consider that at the height of the tulip mania, tulips were the fastest growing export from the Netherlands and the fourth largest export in total.
Like tulips, BNPL is also vulnerable to supply disrupting the current pricing dynamics in the market, because the barriers to entry to this market are easily breached. Most recently we saw Paypal announce their intention to launch a BNPL product, with NAB also getting into the mix with a no-interest credit card.
Demand for BNPL is likely to remain strong, but when considering a BNPL stock for a long-term investment, it will likely pay to ask whether the recent growth can be sustained for a long period of time.
Sam Green is the Portfolio Manager at Emerald Financial, whilst also being an Equities and Derivatives expert for his clients at TradersCircle.
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