The Bubble Question

Everywhere I go, everywhere I speak, I get asked this question. Are we in a bubble?

I’ve been getting asked that question for at least four years now. It’s hard to sustain a bubble for four years. But we are also not in a normal valuation environment for high growth tech companies and we have not been in one for a while.

Here’s how I have been answering the question.

I learned in business school that the multiple of earnings one should pay for a business is roughly the inverse of interest rates. The reason for that is if you buy a business that makes $10mm a year and pay $100mm for it, then you are effectively getting a yield on your investment of 10% (annual earnings/purchase price). This math is terribly simplistic but fine for the purposes of this post. If interest rates are 5% instead of 10%, then you would pay $200mm for the business ($10mm/$200mm = 5%). So the math here is interest rates = annual earnings/purchase price. Again this is very simplistic because it does not deal with the important questions of what interest rate you use, how you deal with earnings that are growing or declining, and a host of other issues. But at the end of the day, this math [annual earnings/purchase price = yield] is fundamental and everything about asset values, capital markets, and valuations stems from it.

Since the financial crisis of 2008, policy makers in the developed world have kept interest rates at or near zero. They have flooded the market with cheap money in an attempt to heal the wounds (losses) of the financial crisis and incent business owners to invest and grow their businesses. That has not worked particularly well but it has worked a bit. Though their words have changed in recent years, their actions have not changed very much. We still are in a policy framework where money is cheap and interest rates are near zero.

If you go back and apply the formula [yield = earnings/purchase price] and use zero for yield/interest rate, then one would pay an infinite amount for an earning stream. Of course that doesn’t make sense and it has not happened. But valuations are at extreme levels because you cannot get a decent return on your money doing anything else.

At some point this will change. The yield on the 30 year treasury yield has been sub 5% since the financial crisis. If (when?) it gets back to the 6-8% range where it was for most of the 1990s, we will be in a different place. Here’s a 40 year history of the 30-year treasury yield. You can see that we have been in a very low rate environment for a while now.

30 year treasury yield

The other thing we have noticed is that this low rate environment has caused asset value/earnings ratios to be non-linear. What you normally see is the value/earnings ratio grows linearly with earnings growth rates. If earnings are growing 20% per year you get a value/earnings ratio of X. If earnings are growing 40% per year, you get a value/earnings ratio of 2x. But what we are seeing is you get something that looks more exponential than linear when you start modeling this out at higher earnings growth rates. When earnings growth rates get to 50-100% per year and look like they can continue to grow at that rate for a number of years, you get value/earnings ratios that are eye popping. It seems that investors are so starved for returns that they are willing to pay that much more for earnings that can grow quickly.

It is the combination of these two factors, which are really just one factor (cheap money/low rates), that is the root cause of the valuation environment we are in. And the answer to when/if it will end comes down to when/if the global economy starts growing more rapidly and sucking up the excess liquidity and policy makers start tightening up the easy money regime.

I have no idea when and if that will happen. But until it does, I believe we will continue to see eye popping EBITDA multiples for high growth tech companies. And those tech companies with eye popping EBITDA multiples will use their highly valued stock to purchase other high growth tech business and strategic assets at eye popping valuations.

It’s been a good time to be in the VC and startup business and I think it will continue to be as long as the global economy is weak and rates are low.

#MBA Mondays#stocks#VC & Technology

Comments (Archived):

  1. Nicolas Wittenborn

    Are we in a bubble?

      1. Nicolas Wittenborn

        Thanks, mate. I will ask him!

  2. James Ferguson @kWIQly

    So in essence demand for current money is low, but demand for future money is high.We are saving for a rainy dayThe treasury solution amounts to bury it in a safe hole in the groundSo anyone who can build a better hole in the ground (safer or faster growing) is on to a winner

  3. William Mougayar

    But if you look at the world of startups, are you seeing fair valuations during raises, or pressures to move them up, and sometimes un-justifiably so?

    1. fredwilson

      what is “fair”?if exit values are going to be sky high, then sky high entry values are fair the valuation environment extends all the way up and down the stack

      1. Matt A. Myers

        It’s true it’s all relative though doesn’t negate whether it’s currently a bubble or not. I imagine those who believe in the high valuations are either knowingly playing the market and their hand as best as they can, or perhaps they truly believe they’re valued at what they are valued at – and that they can maintain the systems and processes they’re started. From my perspective many don’t actually understand why what they have exists how it does and so their foundation isn’t stable, nor are their foundations being reenforced with the best decisions. There is a lot of disruption still possible in most areas online still, and in the real world. Wish I had a good Ben Horowitz rap song quote to insert here.. instead I’ll put another quote that reflects how all companies should be governing:”Be gentle with each other so we can be fierce together.”That’s how you build community and keep community together.

      2. Jim Peterson

        Re:”what is fair”?Great point. If investors see today’s what seems like sky high price become a great bargain enough times, it’s the new “fair”Always going to be people that want part of that action.

        1. pointsnfigures

          normative versus positive economic theory.

      3. MFishbein

        Is relying on exits, especially exits being paid for with highly valued stock, as you said in the post, sustainable? What if it turns out that there aren’t any real profits behind some of these companies and that it’s all based on the lower interest rates you described, QE pumping stock prices higher, and over speculation?

      4. JaredMermey

        is there a latency as the extension makes its way up and down the stack? if so, does it start at the top or the bottom?

      5. William Mougayar

        I agree, but exit levels aren’t known when you enter, so saying it’s a relative thing makes sense in the rear view mirror, not on a prognosis level.there’s some price elasticity that goes on between buyers and sellers, i.e. entrepreneurs and VC’s. If the trend of that ratio goes up without a solid base of support, that’s a contributing factor to bubble in the making. Again, i’m confining this to the world of startup/VCs in the pre-market phases, although private market valuations are influenced by public market valuations.

      6. Shamir Karkal

        Whats slowing down the economy right now is depressed demand for everything, including loans. Eventually this boom will extend from the valley to the US and at some point demand will pick back up and then interest rates will rise and we’ll have another bust. 3-5 yrs is my bet. Also worth noting that banks create money by making loans, central banks just set its price (

  4. pointsnfigures

    Listened to Eugene Fama speak once. He said, “There are no such thing as bubbles.” What he meant was, all information known to the public is priced into the market. As soon as information changes, prices change.I do think that economic incentives are way out of balance because of interest rates around the world-and government spending is at all time highs. When that changes, the market will change. It’s not changing anytime soon.I also believe it when I see VCs say they are seeing things that are revolutionary in how they can change things-not evolutionary. β€œWhat’s different today is that weare seeing on a daily basis revolutionary new ideas, devices, and form factors,not evolutionary enhancements.”-ArvindSodhani Intel Capital in the WSJ (Jan 1. 2014)If the ideas are indeed revolutionary-it’s hard to know which ones will win and which ones won’t. More money gets tossed at them-and the “cost” of that money is closer to 0 than it has ever been. But, the ones that win should transform society and that will mean more economic gain.That may account for the bubblicious math being applied to valuation.

    1. Timothy Meade

      I haven’t seen anything really revolutionary happen in mobile technology. My Galaxy S4 isn’t really that different than an HTC device of 2002 or a Palm Pilot with an added network connection. The speed of the processors and amount of RAM follow clearly from Moore’s Law, the screen size follows market demand which is somewhat irrational and non-specific.The use of devices has expanded in a rapid but predictable pace. One way to look at it is the technology has become more evenly distributed.The software product categories are derivatives of what already existed, WhatsApp is the latest in a line of instant messaging platforms living off network effects, following a predictable adoption curve, and eventually declining as they are replaced. Facebook is one of those with a graph and some photo sharing, which has enabled some marketing engine to sell ads based on supposed user preferences and metrics.At the same time some core technologies in existence since the middle of last century have made substantial progress, owing in large part to the advance in hardware capabilities and some small part to the advance in the algorithms. (As demonstrated in your story yesterday, that can be a huge advantage, but so much of programming follows the cargo cult model that we don’t see too many of those.)Autonomous robotics, speech recognition and real-time NLP are a few examples.King’s IPO looks so much like the acquisition by Zynga of another mobile gaming firm that I’m left confused by the interest and the price tag, CCS will eventually decline in the public mindset and another mobile game will capture our interest. (It may even be made by a total outsider and accidental marketing genius.)Microsoft is about to attempt to fulfill Jobs’ dying desire and deliver a crushing blow to Android, with RIL and FAT patents and some other claim on System V that I can’t quite figure out. Thank you HTC and TomTom.Cable is about to supplant the phone system as the nation’s telecommunications monopoly, at least for fixed communications.The only thing I can consider truly revolutionary: Apple succeeding in establishing a successful OTA market for mobile applications and content, and judoing the carriers into allowing a platform completely controlled by a third party onto their CapEx-heavy systems.

  5. Matt A. Myers

    Bubbles will always exists – large to small. What’s important is whether you’re participating in it or not. Many people play the bubble itself making gains by knowing what the metrics are to a bubble and perhaps even maliciously manipulating it helping a bubble form so then they can benefit from the fallout.Why and how bubbles can come and go and exist at the same time is through the system of pressures that exists throughout the universe, and yin-yang as maybe more widely understood. Badly spent resources cause friction and delay for the good being able to come to full fruition. Though we do need contrast to see what not to do, to be able to learn.Anyway. There are bubbles that exist though all of those resources are pooled into the same tracking systems, so it’s going to be difficult to see.

    1. Mike Dorsey

      Good time to point to a video by Ray Dalio (one of best hedge fund managers of all time) called “how the economic machine works” which goes into great detail about cyclicality.

  6. Matt A. Myers

    Another question is the U.S. in a bubble itself? Whenever you print money (steal money from everyone?) and re-distribute that into systems like saving banks who badly invested their money – is that maintaining a bubble? I still have this feeling that a big collapse is still waiting to happen. The saving grace could be though that the negative impact will be absorbed by developing countries and not so much established economies. Time will tell. I hope for the best.

    1. James Ferguson @kWIQly

      The concept of “negative impact being absorbed by developing countries” being asaving grace – isa) Somewhat vile (I guess you hadn’t thought it through)b) Would not be a work of grace – except in the sense of giving to those who do not deserve.

      1. Matt A. Myers

        I have thought it through. I didn’t say it was a positive or good saving grace – good for the nations taking advantage of it. I agree it’s vile, but that’s what we do — we’re allowing other nations to provide goods to us at a lower cost, and so then they can get things in return – meanwhile at a cost to their society. I loosely used the term saving grace too, more so sarcastically, though realize that didn’t show through.

        1. James Ferguson @kWIQly

          Matt – Great response – I do think we are too “cavalier” about the downstream implications of our decisions. (and have seen sensitive posts from you in the past). I may be over attuned to this as my wife was brought up in Zimbabwe where political corruption and external economic interests have brought a once great country to its knees.So I find myself reacting to (perhaps overreacting to)Edmund Burke β€” ‘All it takes for evil to succeed is for a few good men to do nothing

          1. Matt A. Myers

            You gave the perfect overview example. These processes are the result of capitalism that is unchecked or rather unmanaged. It’s also a side-effect and result of how quickly capital has become available to individuals and how quickly resources can be redirected with little or no oversight or accountability on the individual transaction. The problem goes ten-fold deep though – at least. People are too busy because they’re caught up in the status quo and generally don’t have the emergency time that we all need to allot during time of crisis, during when unfairness is occurring, etc.. and we don’t have this time because most of us are just trying to pay present-moment bills, pay our past-bills (debt), and at the same time worrying about and focusing on the future – so we then have more money so we can have enough for the ever-increasing costs — that in reality are artificially increasing because of pressures of the for-profit capitalist system, in part through the nature of supply and demand – and which of course gets amplified by other mechanisms and systems.We can change these systems very quickly though, however this happens through educating people – and cutting through the noise is very difficult, and educating an unhealthy-distracted-attention-deficit population adds further difficulty – which means this education has to be done in the most practical and digestible way possible, which has many number of important factors to design with/for.This is what I am working on – this is my roadmap. It isn’t what I can explain to most people who I will be presenting my initial project to as it will be messaging overload and dilute its value for the core evangelist group/audience I am targeting/rallying – though this project I am launching very soon will be the leading metric to allow all of the rest of these changes to follow. It’s exciting and at the same time I cry because it puts me face-to-face, confronting the challenges in a raw-holistic view that at its present moment is a momentous clusterfuck.

          2. James Ferguson @kWIQly

            Agree absolutely that education is the key.A) It preserves self-respect (unlike gift aid)B) It engenders autonomy (rather than dependence)C) It is replicable – the pupil becomes the teacherAnd most important it does not undermine local service /product providers as gift aid can. (Note emergence situations are different)

          3. Matt A. Myers

            Re: A) This is similar to my belief being that everyone should feel they’re important; Not the same as self-important.

  7. Stanislas Marion

    So you basically answered yes.

    1. fredwilson

      it depends on your definition of a bubble

  8. Richard

    There are two phenomena in finance, one cyclical and one secular. The interest rate story is cyclical and Fred is spot on (though at times it leads to unexpected things like lower M&A activity). But the bigger story is the secular change going on within large cap legacy corporations. It feels like they are getting out of the R&D business relying instead on the VC/Startup community to bring “it” on. And it looks like (at least for the time being) this secular phenomena is here to stay.

  9. andyswan

    I agree that artificially cheap money is fueling a lot of things…BUT– THAT AIN’T ALL I also think it goes beyond that to a big labor/distribution/impact shift.What’s happening now is that small organizations, or single individuals, are able to do more with their mind than ever before in the history of the world. This results in massive wealth creation (for the individual as well as their audience), which leads to extremely fast and high exits, which leads to fast and high priced entry tickets (early valuations).This is a good thing. It has some side-effects that some short-sighted people consider to be a negative (wealth inequality, disruption of old risk models, etc) but the net effect is amazingly positive.We aren’t in a bubble, we’re in a bull market of leveraging the individual and the human mind…. and it will continue to gain velocity and to reach unfathomable heights.

    1. fredwilson

      yeah, that too πŸ™‚

    2. Richard

      Yep, we said it slightly differently but came to the same result.

    3. Matt A. Myers

      I think a bubble could also exist at the same time. USV is theory-driven and making the bets on helping individuals or startups build great and useful companies. There will be the investors who are more followers and then start to invest based on shallow theory and observations as what they perhaps wrongly see as the leading metrics to the big successes they see.

      1. andyswan

        of course. completely agree.

  10. johndodds

    So, as ever, it boils down to whether the projection of future earnings is accurate or delusional?

  11. Jorge M. Torres

    The amount of money LPs allocate to venture firms currently lags the amount of money venture firms invest in startups. How would a changing interest rate environment affect LP allocation to the venture asset class?

    1. fredwilson

      the big driver of LP allocations to venture is driven by the realization that all the returns (today) are coming from the top 20% of the VC firms. until that changes and a broader base of VCs can deliver great returns, investment in VC by big LPs will be constrained.

      1. andyswan

        That’s impossible

        1. pointsnfigures

          Big VCs get more at bats. More at bats mean higher probability for success.

        2. fredwilson

          what is impossible?

          1. andyswan

            That “a broader base of VCs can deliver great returns”No chance. They (>60% of VCs) are idiots and they are followers.

          2. Richard

            You just came up with Andy’s Law (60% are followers and idiots).

          3. pointsnfigures

            I think it’s actually greater than 60% from my experience in trading pits.

          4. Richard

            Yep, the 60% jumping in is always the last leg of a bull market.

          5. andyswan

            If it’s going to get to “law” status I will need to revise the figure. I was being generous.

          6. sigmaalgebra

            Yes, definitely you’ve beenwatching the old Pink Panthermovies with Peter Sellers whereat one point he says, in oneof his moments of hystericalegotistical mania, about one ofhis subordinates, “Yes, I’m afraidhe will always be a follower.” orsome such!But, but, but, what jobs would there be for chiefs without Indians, generals without privates, leaders without followers????Andy is being so cruel! I mean,”idiots”! After all, maybe theyare kind to their GoldenRetriever dogs, at least iftheir next fund gets checksfrom their LPs!!!!Then they can go back to their2%, dogs, skiing, and CAwines waiting for that nextgreat big deal to crawl to themon its hands and knees, kisstheir shoes, and hand overthe great business they havebuilt because the VC has aRolodex and can give advice,at least on CA wines!

          7. fredwilson

            what if the VC business changes and starts filling up with more visionary entrepreneurial types?

          8. ErikSchwartz

            Even more tools will jump in and the ratio will not change.

          9. Jorge M. Torres

            Exactly. And that is already happening. More and more entrepreneurial managers are pioneering new venture models, some of which are radically innovative. Some names we know – AngelList, 500 Startups, FundersClub. Others are more emergent – i2X, ExitRound, and others. There are entire verticals where lots of innovation is happening, like data driven selection (Google Ventures, Correlation, and others). People often think these new models are crazy and big LPs tend to look at them askance. Not for long. In 10 or 15 years, VC will look very different that it does today..

          10. leapy

            Five years.

          11. andyswan

            That would be fantastic.

          12. sigmaalgebra

            > IdiotsSo cruel! How can you be socruel? And indelicate. Maybesome of them are kind to theirGolden Retriever dogs and children! On a good day, theymight be nice people! Andsome of them made good gradesin English at Williams college, like skiing, and even California wines (yuk!). They have a Rolodex and can give advice!And, yet, you dismiss them justas “idiots”. So cruel!!!!

          13. sigmaalgebra

            Well, that clip from GGGR is fiction, which means that there is only little evidence it’s true.But, I’ve seen such descriptions ofselling before with some examples,and the GGGR clip can be roughlyclose. I have an uncle and acousin who did such things: Thecousin actually did fairly well,got private label commercialjanitor supplies and dominated themarket for half of a major state.But for just real estate, therewas much more money to bemade in the S&L crisis and in the no-doc loans of the 2008real estate bubble and mostlynot by the guys pounding the pavement as in the GGGR clip.The clip illustrates determination,but a rat that gnaws its way through wall board has that,Determination is important butnot nearly all that is important.I’ve seen some of the highestaccomplishment in our societyand at times have had some high accomplishments, and theGGGR clip does not illustrateany of the important lessons.Really the clip is for ‘suckers’ –that’s actually not very good advice for making money.Instead, there are some waysto make money now, e.g., exploit cheap computing andInternet communications. Therethe GGGR lessons are notthe main ones.More relevant lessons include:(1) Find a big problem, that is,one where 1 billion people willpay a little or a few people willpay a lot, enough for a companyworth well over $1 billion. (2)Find a new or much bettersolution for that problem. Forthis exploiting technology canhelp. (3) Have the solutionhave a high barrier to entry,Can get this from a networkeffect, a fad, a solution so goodit is difficult to duplicate orequal. For this, might exploitoriginal, powerful solutionmeans, possibly from originalresearch. The ‘ideal’ examplewould be a safe, effective,cheap one pill cure for any cancer — need some goodnew ideas for that!There is hardly a VC in thecountry who understands suchwork and is able to evaluatean associated proposal. However,for many decades, large partsof our economy have been ableto do quite well evaluatingsuch projects just on paper –high accuracy, low risk. E.g.,GPS, the SR-71, etc.Too many VCs seem to havefallen for some business modeladvice about as insightfulas just the GGGR clip. So,maybe only 20% of them aregetting good ROI. Darwin stands to have the last wordhere.

          14. Susan Rubinsky

            I can’t believe it took this long before someone posted a Glengarry Glen Ross reference!

      2. JLM

        .When LPs have a fixed allocation, say 5%, to “other” — P/E, VC, real esate — when their funds grow, the allocation grows also.A $2B fund that grows to $3B is going to increase its allocation to “other” by 50%.The growth is coming from underlying contributions and huge paper stock market gains.JLM.

  12. Aaron Klein

    Not saying central bankers made the wrong policy choices, but it’s important to note that there is a cost to this “War on Savers” that we’ve been engaged in: there is simply no decent rate of return without much higher risk.Effectively, the couple in their 60s who could have some laddered CDs and a mix of corporate and muni bonds are earning less than inflation on their money.We’ve chosen to take their earnings and give them to other asset classes. Perhaps necessary given the events of 2008, but I don’t think anybody was expecting it to last quite this long.

    1. Richard

      Stepping back from the VC issue. Fed action was motivated by bailing out banks, housing and autos and energy. Everything else (to the Fed) is just noise.

    2. JamesHRH

      War on Savers – if that is your own line, get the URL & get to work. You have a talking head / poitico fortune to make.#simpletruth

      1. Aaron Klein

        Not sure if I could stand for that to be my life’s work! πŸ™‚

        1. JamesHRH

          You & me both Pardner.

    3. ShanaC

      Isn’t that the point of banking – reallocating asset classes for maximum return?

      1. Aaron Klein

        No, definitely not. There is no reason we shouldn’t allow interest rates to float to more of a market level, which would allow savers to earn a reasonable rate of return too.

        1. ShanaC

          the feds are participants in the market – so how is it not the market deciding?

          1. Aaron Klein

            The Fed is definitively not a participant in the market.They shape, control, regulate β€” and some might say distort β€” the market.Huge difference.

          2. JamesHRH

            Shana – they participate like you & I participate, if the c-notes you & I printed in the basement were legal tender.So, I agree w Aaron.

  13. Tom Labus

    Rates are going not going anywhere for some time.The world may have recovered from the shock of 08 but is no where close to being recovered from the repercussions of that madness.There are two major events occurring: First, we are in the early stages of major economic move for the US on the upside and second, there’s going to be a lot of 50 year baristas out there, unfortunately. As it will take a full generation to work out the :”crash”.

    1. Paul Rubillo

      You are probably right Tom. However we may see a bit of Fed posturing if wage inflation begins to creep up. That tends to be one of the Fed’s red flags, aside from trying to cool down the markets, which one Fed governor recently touched on.

      1. pointsnfigures

        no inflation, no money velocity. govt spending is killing turnover of money.

  14. Paul Rubillo

    It will be interesting to see if the supposed pricey startup valuations will take its queue from a Wall Street correction, or if this time will be different and the spigots of money will remain open as generously as they are now, despite whatever happens on Wall Street. My guess is history repeats itself and we see the ultimate clue being a race to get to the IPO runway in order to fully maximize the overall return for private money. Some will get off the ground just in time, while others will see investors’ appetites a bit less open to risk. Sometimes we need a pause to refresh as many great companies will be born in tougher times as much as they are when things are a bit frothy.

  15. pointsnfigures

    Warren Buffett once said, “everyone looks great at the beach until the tide goes out.”. The tide hasn’t gone out in VC during this cycle yet.

    1. LE

      I think you mean this:β€œYou never know who’s swimming naked until the tide goes out.”I was scratching my head (before doing a search) trying to understand how Warren Buffet, who talks in such a simplistic way, would say that since what in the world does the tide going out at the beach have to do with how people look?Also what I’m finding is that “A rising tide floats all boats” is attributed to JFK who said “‘A rising tide will lift all boats’.( First thing I learned in boating was the difference between a floating dock and a fixed dock. Salesman sold it based on “if you have kids you definitely want a floating dock because it’s easier to get the kids off the boat”.)…

      1. pointsnfigures

        guess it’s not an exact quote, but the meaning is the same.

        1. LE

          Opportunity to post a link to one of my favorite Dire Straits songs then. Knopler/Clapton 1988 “Solid Rock” Mandela birthday concert.…This one is from Alchemy tour a bit better audio:…Well take a look at that I made a castle in the sand Saying this is where it’s at you know Couldn’t understand now If I realised that the chances were slim How come I’m so surprised when the tide rolled inLike they say you can’t time the market.

  16. Tiffany Stone

    Completely agree that a financing effect (low interest rates/ease of access to capital) is driving the current valuation environment. I don’t think we are necessarily in a bubble but we are seeing a lot of excitement in the industry because of this effect.Also, I don’t believe there is an answer for the “are we in a bubble” question because I don’t believe bubbles can be recognized while it is happening, at least according to my definition of a bubble. I define a bubble as a speculative process, in which high valuations of an asset or market continue to be undeserved in the long run by evaluation of its business performance, independent of economic factors. As such, in a bubble the overvaluation is purely attributed to individuals and institutions collectively driving up asset values with their expectations of achieving a profit from future price increases and the long-term growth potential of the asset, without fully understanding the invested asset and despite concerns about increasingly significant deviation from the intrinsic value of the asset.My recent post has my full opinion on the bubble topic:

  17. LE

    and a host of other issues.Hah. Such as “is this a newspaper and what decade is this being evaluated in”.The “host of other issues” involves luck, timing and a slew of other things that are really the essence of whether a business is worth any money or not. Which I think in the end are way more important than anything related to earnings or multiples.

  18. Evan

    Since real interest rates are negative…

  19. Guest

    The key difference this time is that “few” players are also controlling the demand side of the equation in most sectors. They have “visibility” to the earnings thus getting ahead of the curve with investments. The nice thing about this is that it allows you to play both sides – long and short. The valuation becomes irrelevant at that point. It is all about the trade.

  20. MogulAzam

    Bubbles can stay suspended for a very long time Just ask Greenspan He was very good at making bubbles He used to make them as Big as a House

  21. Brandon Burns

    So enlightening!This post makes me yearn for the MBA Mondays of yesteryear. I think you’re at your best when playing professor, Fred.

    1. fredwilson

      ooh. i think i will tag this as MBA Mondays. great suggestion

      1. JimHirshfield

        Does that mean I need to start my whole week over again?

        1. pointsnfigures

          Weekday Savings Time.

  22. LE

    I get asked this question. Are we in a bubble?Definitely in a bubble with respect to NYC real estate [1] which, according the the NYT is driven by foreign investment as opposed to fundamentals. The only good news is that real estate isn’t liquid.Separately check out some of the mortgage interest rates circa the 80’s. I actually bought my first house in 1985 and paid some of these high interest rates. Back then though it was assumed (iirc) that you could almost safely earn close to 10% on your money.…[1] Tulip and/or greater fool? Of course depending on when you get out and what your time frame is may or may not be a big mistake.

    1. pointsnfigures

      Is NYC real estate in a bubble with all the world strife that is going on? Better to put your money in a place with property rights than a place like Egypt or Ukraine no?

      1. LE

        Well in the sense that it’s a bit of a dutch tulip. It is because it is.Drive -or- Amtrak 90 miles south to Philly and you will see nice center city neighborhoods with plenty of restaurants and culture sports etc. Sure it’s not NYC but what drives NYC is more brand awareness than the fact that people moving there care about what is in NYC that is not in Philly. I mean all that talk about culture in NYC is way overblown. How many times do you go to the opera that you need to pay $10 million for your dacha or pied a whatever. You can live somewhere else (Philly) and take a fucking helicopter up for less money and stay over in the most expensive hotel in NYC. [1] And still get cute little streets with coffee shops and sophisticated people for way less money.So people invest in what others do and what they are aware of. And what has secondary meaning for them. (Reason I have a Porsche and will pay more for it). But I’m not paying 7x for that car. I’m paying 1.4x for it. That’s the difference. (Figures arbitrary..)The question is why isn’t Philly capturing some of that foreign money by way of branding and marketing? (Because nobody is running that marketing ship, that’s why..) Or Chicago for that matter?[1] I have a friend who lived in a nice house in Philly suburbs (Washington Crossing) and moved with his wife to a rental apartment at Trump in NYC (7k a month I think). Next thing he tells me that for the summer he is renting a place in the hamptons for 75k for the summer. (He is in a family clothing business). Anyway for 75k for 10 weeks imagine how many trips you could take with your wife by airplane and stay at nice hotels and dine out. Yet he wants the hamptons it’s what he wants. That’s branding in action not intrinsic value. There are plenty of wealthy people that you can hang with at the Jersey shore (in the right spots) with houses that you can rent for 30k for the summer that are on the beach and still have money left over. (Btw he’s not so rich that 75k is meaningless if that were the case I agree go with the brand and all). This year I hear he is getting a bigger place. The 75k place looked to me like a typical suburban home that you can get anywhere. Wasn’t near the beach nothing special at all. Formica.

  23. LE

    I have no idea when and if that will happen.You will know before the average person though since you are more privy to the canaries in the coal mine.

  24. goldwerger

    One of the many places this can be seen in the capital food chain is angel investing. The amount of capital, and people, participating now is at an all time high. I think that tranche is one of the quickest to move either way (as individuals move faster than institutional fund cycles). Therefore when eventually interest rates/other asset yields go up, many angel investors will bail out.(unrelated to the post, but related to this topic, “seasonal” angels often do not have full appreciation of illiquid startup life cycles and hit ratios, and stepping in and out rather than staying the course over time may exacerbate their final predicament/returns).

    1. JLM

      .Excellent insights. Well played.JLM.

      1. Guest

        thanks JLM πŸ™‚

      2. goldwerger

        Thanks JLM πŸ™‚

    2. PhilipSugar

      Agreed. I have said this a ton of times. There is always going to be a cycle. When who knows? I have seen three in my entrepreneurial career PC/Internet/Mobile Social (whatever you want to call today)I have seen tons of angels come and tons go. There are very rare angels that span the cycles.

      1. goldwerger

        Indeed Philip. Those who stay, are those who know what they are getting themselves into, and are in it for the long haul… (like one-time entrepreneurs vs. serial entrepreneurs…)

    3. JamesHRH

      This is a very interesting angle.The Law of Unintended Consequences would really like this – G20 protects friends on Wall Street while cushioning the blow for the worst personal credit offenders……but accidentally fuels an innovation boom that eats the lunch of both those groups!Nice. #karma

  25. JLM

    .Of course we are in a bubble. Bubbles are not all about Danger, Will Robinson, Danger! Sometimes they are just normal growth at levels that are difficult to absorb smoothly, the drinking from the firehose effect.In some ways, this is the “new normal”.The new normal includes a very high rate of unemployment, almost non-existent job creation and ridiculously low interest rates.Here a few of the impacts that are “different”:Interest rates are incredibly low but community banking has disappeared. No small business can really avail themselves of low costs of debt because the loan window is effectively closed. Small business — not tech business — was created by community banking.Huge flows of funds continue to create a riptide in the public markets. Every 401K, IRA continues to pour money into the markets thereby driving them up on an oversupply of money basis. The markets are rising with no real connection to the underlying value of stocks. It’s almost all unbridled demand caused by money flows.VC is a very small part of the financial model. This performance is not indicative of anything other than VC. It is not a view of the economy. The failure rate continues to be enormous — 75%. The successes are almost all funny money, hugely over valued paper and absurd IPO valuations. So what? It’s still a small part of the financial world.Unemployment is incredible. Screw U-3, look at U-6/7. And yet, the unemployment rate in places like Midland, Odessa — Oil Patch —is almost zero. People are not willing to relocate for jobs.Given what is happening in the world, all the money that can is moving to physical “safety”. The Middle East is one of the greatest concentrations of wealth in the history of mankind and it is all apparently buying London real estate.Nobody is doing anything to get US spending under control. The President’s recent budget submission increases spending and raises taxes. Nobody has even said the word “entitlements” in about two years. We are crackhead spenders and that creates an artificial level of prosperity. Government spending is, in part, creating the bubble because we continue to eat dessert first, second, third.Only in America could you be considered an extremist and a radical if you espoused spending discipline, entitlement reform, a balanced budget, deficit reduction or managing the national debt.So, yes, we are in a bubble and it’s likely to stay that way. For a long time.BTW, the Cold War is back from vacation and that’s going to increase spending yet more. You think it’s bloody likely that the US will reduce military spending now? The Russian bear is one country away from sticking its nose into the NATO honey pot and Article 5 requires us to go to war over Latvia, Estonia and Lithuania. Most people don’t even know where they’re located or the fact they are members of NATO.Thank God we didn’t let Georgia or Ukraine join NATO.JLM.

    1. Dave W Baldwin

      I think the Budapest Accord regarding Ukraine is more on top of the pile. Still think my idea shared on your blog (surrounding the Russian ship over here and take our time determining possible hostile intent) is the best way to go.

    2. ZekeV

      What happens when the bubble ends? If the macro picture is so distorted, there must be an adjustment eventually (even if not for 20 years). I can’t think of any clever strategy to plan for that event…

      1. JLM

        .The big issue is the unsustainability of the current American economic picture.You cannot run deficits and increase the national debt forever unless you have such massive growth that the deficit and national debt as a percentage of GDP begins to decrease dramatically.Right now that is not in either the cards or the CBO projections. Deficits and increasing national debt as far as the eye and spreadsheet can see.Growth is always the answer to economic problems.Growth while curtailing and containing spending.Growth and inflation.You cannot eat 5 cheeseburgers a day and expect to live forever.JLM.

        1. ZekeV

          That sounds a lot like what Alan Greenspan has been writing about lately. Not sure what to do with this info though. If there’s just a period of inflation (maybe combined with stagnation due to gov’t crowding-out) like the 70s, that is fairly boring. But could there be hyperinflation like Argentina? Or, will structural mispricing of assets lead to a sharp adjustment and extreme contraction like 2008 only worse? I have no idea how to plan for the future in this environment.

    3. andyidsinga

      ive been thinking about the Baltics & Poland lately ..yikes

  26. Eduardo Teixeira

    In the end when you say it will continue so as long as interest rates are very low, that’s financially perfect. But (there is always a but) when it changes (and it will but I don’t know either when is it going to be) investors with their portfolio full of “crazy valuations” might have some trouble making their investment multiples. I am not saying anyone is wrong or right but thinking on the long term (where interest rates are not 0) usually works out better than surfing short terms craziness…Great post!!!! Really liked some financial data here

  27. Semil Shah

    This is the key line: “But valuations are at extreme levels because you cannot get a decent return on your money doing anything else.” Agreed. No where else for capital to go.

  28. Kirsten Lambertsen

    Paul Graham makes a pretty good statement about ‘is this a bubble?’ in his interview with JCal at Launchhttp://thisweekinstartups.c…starting at 42:26.It resonated with me. It doesn’t feel like a bunch of people holding things that they hope to sell to a ‘greater fool’ later… yet.

    1. andyidsinga

      i been wondering if the expensive acquisitions are the greater fool later

  29. sigmaalgebra

    My guesses: Maybe the relationship between earnings and value seen recently is due to the values of Snapchat, Whatsapp, etc.But such companies are in a very specialM&A ‘market’: Or, maybe Zuck sees all thatcash on his balance sheet and is afraid otcompetitors. If he can keep his dominanceof his users and network effect, then he canmake ‘natural monopoly’ earnings. If his’natural monopoly’ and network effects getpunctured, then his earnings will comecrashing down to earth and turn his business into something ordinary.So, he is willing to buy up nearly anythingat nearly any price in an effort to keep uphis special position in his ‘market’. Andfor such M&A deals, there are a few competitors with somewhat similar thinking –Google, Microsoft, and a few more. So,for those special buyers, the M&A prices arethrough the roof, but only for those specialM&A buyers. Again, the fundamentals arethose special buyers are awash in cashand trying hard to maintain their nearmonopoly status. If they can maintaintheir status, then they will have a licenseto print money and will be able to affordthose outlandish M&A prices.So, net, the M&A prices are not from a’market’ with a lot of buyers and sellersas is sometimes imagined in econ theory.This thinking also sheds light on theprices paid for ‘acquire hires’: Insome cases the goal is just to buyout and, then, essentially shut downa potential threat. It might be likeExxon buying up and shutting downTesla or Joule Unlimited or some such.

  30. Steven Kane

    great post fred. thank youbut i kind of have to question the basic premise, at least when it comes to VC and techfor one thing, VC and tech valuations do not work this way – or at least, do not commonly do so. many if not most of the big exits (public and private) in VC for the last 10 years have actually had little or no earnings. zynga. twitter. youtube. whatsapp. tumblr. instagram. admob. quattro wireless. groupon. millenial media. pandora. even amazon. and those are big names. the vast vast majority of smaller exits have no earnings also. tech startups are usually funded and acquired/exited (if they are successful) based on a vision of the future, disconnected from financial reality, and not on a multiple of present results… no? (of course, plenty of notable exceptions: facebook, uber, etsy, ebay, paypal, google, yahoo, microsoft…)also, a historical note:i’d argue the super low interest rate environment actually began in 2001, when the bush admin and greenspan radically lowered interest rates to offset the double whammy pain of the tech meltdown of 2000-2001 and then 9-11. the result was… a bubble, in real estate, as everyone went on spending sprees of super cheap money. everyone was feeling so burned by the stock market and tech, that no one wanted to invest there so real estate (note: REAL estate) became the asset category of choice. the whole thing went super nova when even everyday middle class and even poor people got access to cheap easy money and went all in, like everyone else etc.then in 2008 the powers that be decided to address a crisis of super excess liquidity… by radically increasing liquidity. and they had to *start* from the greenspan level rates and so went lower, and even lower, to where we are now. truly historically bizarrely awash in liquidity.the effect has been massive asset value appreciation, principally from huge inflows into the stock markets, which has swelled the valuations of acquirers who then pay more for acquisitions and also swelled the values of pensions and endowments, who then send more dollars into VC and PE etc etcand awaaaay we go.if we ever actually mop up excess liquidity (is it possible we never do?) the effects will be profound…

  31. jason wright

    is it technically possible with disqus to time stamp the moment you publish your daily blog post?

  32. Dave

    Definitely lots of macro forces at play with the interest rate environment and other factors but…Another way to think about the very high multiples is that in a very low growth (but not bad) economic environment, the value of any business with rapidly growing revenue increases exponentially. Most of the large tech buyers have benefited from this relatively stable, but slow growth environment. They have increased profitability through efficiency gains, offshoring, price increases and other means. But they cannot find revenue growth no matter what they do. So they go buy revenue growth. Because there are many similarly situated buyers, the cost for premium growth businesses continues to rise.Investors in public markets are not dissimilar in that they have some solid, but slow/no growth investments. Plus any smaller companies with high growth in the public markets start to command a huge premium on the assumption they may/will be bought.

  33. Andrew Ghezzi

    The mechanics of value/earnings ratios and EBITDA multiples have been stretched due to the strong actions both domestically and internationally to effectively contain exogenous risk. Its a slippery slope we are on now and equally as hard to isolate returns in a fundamentally unique environment.

  34. Steven Kane

    btw, sorry if i’m late to the party but the new design is awesome

  35. kenberger

    that popping eye is clearly eyeing the whatsapp story that you’d said you didn’t give a shit to blog about πŸ˜‰

  36. JamesHRH

    In short, environment matters.

  37. Nic Lowe

    I hate your conclusion – surely there is a better reason to be in the startup business better than ‘economy is weak and rates are low’?

  38. ShanaC

    This sounds very nineties – valuations don’t make sense because the fundamentals are different. So basically, that’s a bubble.

  39. SamT

    I asked myself this question a few weeks ago with the $3.2B acquisition of Nest by Google. I went back to a few other “jump the shark” acquisitions from the late 90s to compare. Yahoo’s $5.7B acquisition of, and AOL’s $14.6B acquisition of Time Warner.I decided to compare the purchase price multiples based on the _acquirer’s_ EBITDA. The goal was to see what fraction / multiple of the acquirer’s annual cash flow at the time (proxied by EBITDA) was paid for these deals.$3.2B is an awful lot of money for Nest at this stage in its life, but it represents only 0.2x of Google’s EBITDA. Even if Google didn’t have a $50B+ cash hoard, it can easily finance this purchase price out of a few months’’s $5.7B acquisition, by comparison, was a whopping 32x Yahoo’s $179M EBITDA at the time of purchase. Of course, the deal was paid almost entirely in equity (100%?), but for comparison’s sake, you can see the valuation was getting out of hand.And finally, AOL’s $14.6B acquisition of Time Warner was a 210x multiple of AOL’s EBITDA at the time.So what do I conclude? If you can call it a bubble, it’s a very different kind than the one we saw in the late 1990s/early 2000s. That one was fuelled entirely by hype. This one is fuelled by strategic acquirer’s — companies who have already made piles of cash — casting about for ways they can continue to diversify their business models and pursue their longer term strategies.It’s creating a “valuation bubble” of sorts. But those acquirer’s cash piles are not going away anytime soon, either.

  40. Vivek Krishna

    Great Post! Note however that earnings used to calculate yield in your first couple of paragraphs, really means free cash flow generated by the business. Correct?

    1. fredwilson


  41. Anthony J. Alfidi

    Even the BIS reports have recognized the bubble distortions brought on by central bank QE in the developed economies. It’s not just a US phenomenon. Broadly owned blue chips have played this for all it’s worth, using ahistorically high earnings to buy back shares and inflate their P/E ratios. Here’s a helpful set of Venn diagrams for those who need a map of the bubble:

  42. Yniim

    I summarized your post and added my point of view [in french] :

  43. andyidsinga

    like the post. so im reading this as : the non-linear part is the bubble

  44. LE

    To me it’s a bubble because people are pulling pricing out of their asses and there is a rush for developers to take advantage of the fact that the foreign buyers don’t know enough to really know the true value. And that most importantly they don’t have time to truly understand the market. Like if I was going to fly to some place and buy real estate I have to make quick decisions so I am going to make stupid decisions. And anyone selling knows and takes advantage of that. It’s the collective mentality of the group (variation of the “only as honest as your competition”).Anyway that Russian and Chinese money is an abnormal market force in action.If it were a smart-er business move you’d find corporations getting in on the act (like how they bought all these short sales en masse across the country recognizing the value to resell or rent). Not saying corps don’t do stupid things they do.So the entire thing is inflated.The brokers (and the NY Times) have them totally wrapped around their fingers with this one.FWIW I had a great year last year (and year before) selling high priced domains to chinese buyers and their money. Don’t expect it to last however.

  45. LE

    So then what happens when they discover some other shiny ball and money starts to go there? 12 years isn’t a long period of time.Do you read the NY Times real estate section every week? I do. It’s one big hype machine about the value and scarcity of real estate in the city with a smattering of “to be sure” and heavy on anecdotes. It’s one big echo chamber. You wish you hadn’t sold because of hindsight which is 20/20. If it were that clear at the time you wouldn’t have sold.This was an interesting article from last week I like what this guy is doing (doing something real, not chasing a dream):…Anyway these foreign owners are basically facing up to the lesser of two evils (keeping money in their country let’s say). As such their appetite for risk is much higher. I fail to believe that someone can buy an expensive place in NYC, rent it out, and without continued appreciation in real estate they won’t loose their shirts. And that continued appreciation is by no means assured. No way the rent is covering the oppt cost of money, taxes and expenses for them. Let alone making a return.That doesn’t make them experienced and sophisticated it means that they are jumping out of the building because it’s on fire. (Hey just made that one up..)

  46. LE

    Yeah I know about that truism and all of that. “They are only making so much beachfront” [1]So with respect to “beachfront and manhattan” the point being the true supply increase is there as yes I agree that people want to live in the city vs. Lancaster, Philly or god forbid Allentown or the Poconos.But the foreigners are hypering that increase way beyond the base demand would increase because of “only so much beach and NYC”). (Latin money in Miami is doing a similar think btw my parents have a huge offer on their condo because they want to tear it down and build luxury condos).How long has your friends son’s been selling re for? My guess is that he’s young which of course assumes your friend is your age (40’s?) (I mean he could be 70 and his son 50 also..)[1] As opposed to musicians or artists.

  47. SubstrateUndertow

    Isn’t the low interest policy simply a convenient monetary contrivance to rob savers in order to subsidize the costs associated with carrying huge amounts of public debt ?Huge amounts of public debt accumulated over decades of insufficient tax revenues ?Insufficient tax revenues generated by decades of unrealistically-week/non-existent trade/industrial policies, banking malfeasance, financially corrupted governance and pointless war expenditures ?Aren’t unsustainably short-sighted off-shore profits being subsidize by taxpayers and savers, all while stalling the job market and killing the middle class goose that once laid an ongoing stream of renewable golden eggs ?Isn’t that the dynamic that is accelerating the concentration of wealth to a point that threatens to collapse the cyclicality of economic stasis ?Sure, realistic trade/industrial/tax policies drive down profits but the trade off is a sustainable cyclical equilibrium between corporate-profits, tax revenues and wages.How can profits that don’t go around as wages continue to organically cycle back around as sustainable profits ?Hasn’t it become patently clear at this point that concentration of wealth in not so much immoral as it is mathematically unsustainable ?It is the 21st century!Isn’t the internet just our open invitation into an organic world dominated by universally networked interdependent social-synchronicities ?Dosen’t that signal an urgent need to started viewing/analyzing human economics as an instantiation of complex interdependent organic homeostasis ?Isn’t this continual effort to rearranging the deck chairs on this old linear 19th century economic paradigm just pointlessly scratching the iceberg on this intractable Titanic problem ?Isn’t a more ambitiously interdependent/integrated economic solution simply mandatory this time around if we are to escape our present globally-interdependent economic-spaceship predicament ?Sure, I know that all sounds like “pie-in-the-sky” raving lunatic material but at this juncture in social-evolution isn’t reality simply offering us a very stark and challenging existential choice between organic “pie-in-the-sky” or “die”? Is anyone delusional enough to think it is even possible to putting this organic-social-interdependence “sky-in-the-pie”, this societal-organization-phase-change survival-challenge , back in the bottle!Everyone wants a decent social/economic infrastructure but no one wants co-operate on paying the freight !The question is:Does the myopic evolutionary-nature of human volitional self-interests and its resultant ubiquitously endemic over-concentration of wealth, power, education and control constitute an evolutionary-original-sin that simply sets an upper limit hull-speed to human social-evolution that banishes us from entering the kingdom of organic social/economic dynamics ?In short:Have we reach our genetic evolutionary cup-de-sac or can clever collaborative organizational-abstractions grant us a little more evolutionary rope with which to move forward ?

  48. SubstrateUndertow

    Well that is often the case with such”pie-in-the-sky” raving lunatic material πŸ™‚

  49. Cam MacRae

    What rate do you have in mind for opportunity cost?

  50. LE

    At least the rate of a mortgage, say 4%.