The concept of "big market delusion", coined by American scholars Cornell and Damodaran in 2019, refers to the fact that investors often overestimate the value of companies with broad market prospects. However, this overvalued value will eventually revert back to a level consistent with the company's fundamentals, resulting in losses for high** investors. This phenomenon deserves to be explored.
Investors' preference for companies with promising market prospects is a natural business instinct. After all, the larger the market, the greater the benefits a company can gain from economies of scale, including higher revenues and profits. For example, companies often have significant differences in valuations in countries of different market sizes. In China, which has a large market, a large population, strong purchasing power and a large economy, similar companies may be valued at a higher level than in Vietnam, which has a smaller market. This also explains why the companies with the highest market valuations are usually large multinationals – they not only cover their home markets, but they also have a global presence.
However, this quest for a broad market can lead to a misjudgment of the company's value. While market size is an important factor, it is not the only criterion that determines a company's success. Ignoring a company's fundamentals, such as profitability, competitive position, management capabilities, etc., in valuation, may lead to biased investment decisions. Over time, the value of overvalued companies will gradually return to rationality, and those investors who enter the market during the overvalued period will face losses. Compiled by Sun Guangjun, a Qianji investment bank.
It's natural for investors to pursue companies in the big market**, but this often comes with the risk of losing money. Even in a market that appears to be full of great opportunities, it is not easy for companies to succeed. At a minimum, there are a few key elements that need to be met for a business to succeed:
Occupy market share: It is a basic requirement to occupy a certain market share in the main industry. But it's not an easy task, especially in large industries. Large-scale industries are highly complex and face many challenges, such as laws and regulations, local policies, and fierce competition in the industry. If a company fails to gain a certain market share, it will not succeed even in a large market.
Profitability: Profitability is the key to measuring a company's long-term survival and success. In many cases, earnings and growth are contradictory. Companies pursuing rapid growth may have to sacrifice short-term earnings. However, patience in the capital markets is limited, and investors ultimately need to see that companies can achieve real profits.
Build a moat: The key to a company's competitive advantage for ten or even thirty years is whether it can build an effective moat to resist competition. Industries with large enough profit margins attract a large number of competitors. If a company fails to build an effective moat, its competitive advantage will be fleeting and its share price will not be supported in the long term.
As a result of these factors, there are many examples of companies that have failed, even in industries of great size and unlimited growth prospects. For example, the American aviation industry at the beginning of the 20th century is a prime example. At that time, the aviation industry met all the conditions of a "big market": the technology of aircraft manufacturing was maturing day by day, and more and more people were choosing to travel by air. **Vigorously support infrastructure construction, a large amount of money invested in aviation**. However, throughout the 100-year history of the U.S. airline industry, almost all airlines have gone bankrupt or been acquired by investors, and investors have not received the expected returns. Warren Buffett once pointed out: "Breakthroughs in new technologies do not guarantee that investors will get rich unless effective barriers to entry can be established to achieve excess returns that are higher than the cost of capital in the long run." Compiled by Sun Guangjun, a Qianji investment bank.
The history of the aviation industry is just one example of how many investors have failed to learn from the past. To this day, many investors are repeating the same mistakes, and a big reason behind this is the pervasive behavioral trap of overconfidence, which manifests itself on two main levels.
First of all, overconfidence at the entrepreneur level. Starting a business is a high-risk activity in itself, and the chances of success are slim to none. In order to survive, entrepreneurs must maintain a high level of self-confidence and optimism, even paranoia. Especially in the field of technological innovation, entrepreneurs are often convinced that their company will stand out from the fierce competition. This self-belief leads them to value their companies as leaders and survivors in the industry.
Secondly, overconfidence at the VC level cannot be ignored. The task of a VC** manager is to find future winners among the many startups. In high-tech emerging industries, where startups are numerous and competitive, it's often a winner-takes-all approach. Therefore, when VCs choose to support a company, they often have to believe that the company can win in the cutthroat competition and become a unicorn in the market, so as to deserve a high valuation.
The combination of these two levels of overconfidence has led to the fact that invested startups are often valued as survivors in the market. However, very few companies actually survive and become market leaders. This means that most of the companies that fail to survive tend to be overvalued, and the investors who buy them** may end up being the losers.
Electric Vehicle Industry: Investment Bubbles and Collapses in the Illusion of a Big Market.
The electric vehicle (EV) industry is a classic case of the "big market illusion". Almost all major countries are committed to energy conservation and emission reduction, and it is expected that in the next 10 to 20 years, the majority of the world's vehicles will switch to hybrid or pure electric vehicles. This broad market prospect has naturally attracted the attention of many investors.
Between 2018 and 2021, the market capitalization of global automakers increased by 70% to about 2$16 trillion. This growth is almost entirely attributable to EV companies, while the market capitalization of traditional non-EV manufacturers is largely flat. The market has high expectations for the future of electric vehicle manufacturers. For example, between 2020 and 2021, the share prices of some electric vehicle companies have increased staggeringly: Nikola (2,800%), NIO (2,150%), Alcimoto (1,770%), Electra Meccanica (700%), Tesla (600%), BYD (500%), Xpeng (150%), and Ideal (110%).
In January 2021, the combined market capitalization of the above eight EV companies reached $1 trillion, of which Tesla accounted for about $732 billion. The combined market capitalization of the remaining seven companies is $268 billion, which is equivalent to the combined market capitalization of Germany's three largest car companies (Volkswagen, Daimler, BMW), or the combined market capitalization of Toyota and Ferrari.
The price-to-sales (PS) ratios of these companies are even more shocking compared to their share prices. In January 2021, the market-to-sales ratio of electric vehicle companies generally exceeded 20 times, much higher than the 11 times. Among them, companies like Nikolai have unusually high price-to-sales ratios, despite having almost no operating income. Xpeng and Ideal have a high P/S ratio of 47 times and 52 times, respectively, which is almost double that of Tesla (28 times). This shows that the market value of electric vehicle companies has advanced the sales growth expectations of the next ten years or even decades.
However, over time, this bubble began to burst. From January 2021 to October 2023, the market capitalization of these EV companies has changed significantly: Tesla is down 27%, BYD is down 6%, NIO is down 88%, Xpeng is down 70%, Ideal is up 1%, while Nikola, Alcimoto and Electra Meccanica are down 95%. Of the eight EV leaders, most have caused huge losses to investors.
In addition, there are many unlisted or closed electric vehicle companies, such as Weimar, Reading, Evergrande, etc., which are also victims of this big market illusion. This up-and-down in the EV industry not only reveals the volatility of the market, but also exposes the over-optimism and irrational behavior that investors tend to fall into when facing the broader market. Compiled by Sun Guangjun, a Qianji investment bank.
Even today, the electric vehicle industry is seen as a promising "big market". But the ever-changing market presents investors with complex and contradictory challenges. Electric vehicle companies that have experienced a sharp drop in stock prices may still have a chance to turn around. In this volatile market, whether investors can find a balance between risk and return to achieve the desired investment return has become a key consideration.
Don Valentine, founder of Sequoia Capital, once noted, "Our goal is always to build large companies. If you don't go into a big market, it's hard to build a large company. "This mindset has also deeply influenced many investors, who are keen to find the next star company in the big market. However, as savvy investors, we must be wary of falling into the trap of the "big market illusion". This illusion can lead investors to blindly follow the herd and invest in companies whose valuations are far removed from their fundamentals.
The key to long-term survival and success in a volatile capital market is to have a deep understanding of who you invest in and to remain cautious. When making decisions, investors should not only be attracted by the broad prospects of the market, but should also comprehensively analyze the company's financial health, profitability, competitive position in the market, and long-term growth potential. Only by taking these factors into account can investors move forward in a volatile market and ultimately achieve their investment goals.
In addition, investors also need to pay attention to industry dynamics and adjust their investment strategies in a timely manner to cope with the rapid changes in the market. In these uncertain times, flexibility and continuous learning are indispensable skills for every investor.
* ft compiled by Sun Guangjun.
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