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Opinion: The latest sign of a stock market bubble: Small companies claiming to disrupt large industries

Investors can’t get enough of insurance startup Lemonade, which is tiny and unprofitable

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The stock market is complex. Many investors are having difficulty making buying and selling decisions lately.

We can gain an insight by reviewing mobile-based insurance startup Lemonade LMND, -1.94%, which is the best IPO of 2020. It went public last week.

Let’s first build the foundation for this topic with the help of a chart.

Chart

Please click here for an annotated chart of the Dow Jones Industrial Average ETF DIA, +0.10%, which tracks the Dow Jones Industrial Average DJIA, +0.10%.

Note the following:

• The chart shows the latest buying in the stock market, propelled by Chinese euphoria. The Chinese government signaled that it is a good time to foster a bull market in stocks. Of course, Chinese investors complied, running up the Shanghai Composite Index 5.7% in its biggest gain since 2015.

• In round robin buying, European investors followed the Chinese, and the momentum filtered through to the U.S.

• The chart shows that before the great recession of 2008, the Federal Reserve’s balance sheet stood at $0.87 trillion.

• The chart shows that in March 2009, when a major Arora buy signal was given, the Fed’s balance sheet stood at $2.08 trillion. With the benefit of hindsight, this also turned out to be the start of the long bull market.

• The chart shows Arora buy signals and calls for the Dow Jones Industrial Average to reach 30,000 points. From 2012 to this point in time, the majority of the rise in the stock market is attributable to the rise in the Fed’s balance sheet and lower interest rates. Please see “Here’s the case for Dow 30,000 in Trump’s first term.”

• Even though Joe Biden outpolls Donald Trump, it is too early to call the election. Investors should consider various scenarios.

• After Trump’s election, a big part of the rise in the stock market is attributable to the rise in the Fed’s balance sheet, tax cuts and reduced regulation.

• If Biden gets elected, he is committed to taking back most of Trump’s tax cuts and adding regulations. In theory, a large part of the gains in the stock market should disappear if Biden does what he says.

• The chart shows that the stock market touched the “mother of all support zones” on the coronavirus scare and then rebounded strongly. The main force behind the rebound has been the Fed’s expanding balance sheet and the government borrowing for stimulus programs. The chart shows that the Fed’s balance sheet is about $7 trillion today — on its way to $10 trillion.

• A major contribution to the stock market has been made by big money hiding in the big five tech stocks of Apple AAPL, +0.61%, Amazon AMZN, -0.93%, Microsoft MSFT, +0.91%, Alphabet GOOG, +0.22% GOOGL, +0.26% and Facebook FB, -0.53%. A significant part of the rise in the five stocks is due to their price-to-earnings multiple expansion, not improved fundamentals.

The Lemonade stock market

With the foregoing foundation, let’s focus on Lemonade and why it’s important.

• To become the most successful IPO, Lemonade did not find a cure for the coronavirus or cancer. Lemonade sells simple 澳门拉斯维加斯app下载homeowners’ and renters’ insurance mostly at the low end.

• Lemonade priced its IPO at $29 a share, higher than the already increased range of $26 to $28. This shows the high demand for the stock.

• After the IPO, during the first day of trading, Lemonade stock reached a high of $70.80 and closed at $69.41. You must be thinking that for the stock of a company that mostly sells insurance at the low end, such heavy demand from buyers means that the company has a dominant market share, billions in revenues and hefty profits. You would be wrong.

• In 2019, the company generated only $67.3 million in revenues and lost $108.5 million. A typical insurance company would be in danger of going bankrupt with those kinds of numbers.

• It is in fashion these days to blame some of the insanity of the market on Robinhooders. Robinhood is a discount broker, and some believe that Robinhood’s clients just do not know enough and keep on running stocks up based on social media and momentum.

• Lemonade is no Robinhooder stock. It has been brought public by the cream of Wall Street crop, including Goldman Sachs and Morgan Stanley. Its investors include famous firms such as SoftBank and Sequoia Capital.

• At the close of its first trading day, Lemonade was worth $3.81 billion. This translates to a price-to-sales ratio of over 56. No, not the price-to-earnings ratio — there are no earnings.

• Warren Buffett is in the insurance business. Buffett’s company, Berkshire Hathaway BRK.B, -0.61%, gets a price-to-sales ratio of 1.84. If you have followed Buffett, could you see him paying even one-quarter of the present price for this stock? (Buffett has been busy buying the natural gas assets of Dominion Energy D, -0.37% at a great price.)

• Why are investors so enthused? They remember that Amazon was just a book seller once upon a time and incurred heavy losses — the inference, perhaps mistaken, is that heavy losses to generate growth are always a good thing. Lemonade has reimagined insurance for the digital age. You can buy insurance from your phone. You do not need a broker.

• In the late 1990s, companies achieved sky-high valuations because they had “.com” in their names. In many cases, all they had to do is announce that they were going to have a new website, and the stocks jumped. Investors did not need to know anything else.

• Today’s monikers are artificial intelligence, big data and the reimagining of new industries. Lemonade has all three. It uses artificial intelligence and big data to make decisions and is reimagining a big market.

Bubble

If you still do old-fashioned, cold analytical analysis based on numbers, you’ll see that the stock market is significantly above the mother of support zones. It is now a bubble.

Lemonade and Chinese officials are showing us that the bubble is likely to get bigger. To make money in this market, investors need a new mindset. The mindset is easier to develop once you recognize Lemonade-like companies springing up.

As a note of caution, it is important to keep protective measures in place and stay nimble because there is a tail risk of the bubble busting. The alternative is to miss out on gains. There are always opportunities, even for old-fashioned, prudent investors. Please read “Here’s the secret sauce to handle the stock market’s election and virus fears.”

Disclosure: Arora Report portfolios have positions in Apple, Amazon, Alphabet, Microsoft and Facebook. Nigam Arora is the founder of The Arora Report, which publishes four newsletters. He can be reached at Nigam@TheAroraReport.com.