Friday, July 24, 2015

Amazon and Google Jump

               Remember the value of a company equals the present value of the market’s expectations of future cash flow.  For the value to jump overnight, it must be the case that the market’s expectations have been significantly altered.  (The discount rate is unlikely to change overnight except possibly in times of crisis.)  Recently, both Google and Amazon announced better than expected results and both stock prices jumped almost 20% overnight.  As an investor, the question you should ask is what news justifies that result?  Both companies stock prices, particularly Amazon’s, already incorporated expectations of rapid growth.  Prior to the jumps both company’s stock had also risen sharply relative to the market with Amazon up about 55% compared to the S&P 500 so the market was already incorporating ever more bullish expectations.  Was the news so much better than those expectations that it warranted at 20% upward valuation in the company overnight?  While that is not impossible, it does seem unlikely.  At any rate, at the new loftier valuations it raises the question of how future expected returns could possible justify the risk at such valuations.