Fresher :
Yes, but that seems to be a management issue. I'm curious: how would y’all as tech analysts go about investing in this space?

Analyst :
Well, The book of value investing says 'trust the PE ratio.' The P/E - price to earnings ratio! If one company in the industry is trading at 10 times the earnings of that company, all the other companies in the space should trade at 10 times of their respective earnings.

Senior Manager :
Wait a minute! Apart from numbers, I also see this philosophy in value investing - if you find a great company with good management and if that company has competitive advantages, stick to it!

Employee :
Absolutely. This is what we're taught. And we're going to make mistakes by being too active or not by being too passive, and buying and holding for rest of their life and your life is a good thing.

Fresher :
Aren't we also taught dividends are good things to rely on? I've always been told share buybacks are less trustworthy, so invest in high dividend paying companies.

Analyst :
As a technical analyst, I'd say that each of the above advice is bad advice for a tech investment!

Employee :
I'm really confused. Also the PE? It's such a straightforward and logical measure. Everyone uses it all the time.

Analyst :
You're not wrong. It is, but earnings are a function of the tech life cycle and how they're subjectively measured by respective accountants.

Fresher :
This is news to me. I thought that all companies are governed by the same accounting standards.

Senior Manager :
Kid, say this to an accountant. He'd give you excuses for the inconsistency in the reporting of earnings. If I'm a manufacturing company; my land, plant, and machinery are not treated as ordinary expenditure but as capital expenditure. It doesn't reduce my income; it's an investment.

Fresher :
This is even more confusing. How's buying a plant gonna come in the picture at a tech company? They start in small spaces and hardly need anything other than laptops and servers.

Senior Manager :
Kid, their biggest CapEx is research and development. But unfortunately, it's not treated as an investment, but expenditure. If you take that away from my earnings right now, the earnings will tend to get understated - especially when R&D is done in the early life cycle.

Employee :
Sir, are you saying that if you are a value investor, opting the PE metric here - you will end up avoiding the tech companies during the growth period - because they are going to look expensive to you?

Analyst :
Yes. Ideally, lower the PE, better it is! But for the reason I mentioned, a tech company will have low earnings in the denominator and so couldn't have a low PE! In fact I'd go on adding, the PE is such a ridiculous measure for the tech companies that you'd be buying companies that have no RandD and so would have higher earnings. These are the type of companies that are in the decline phase.

Senior Manager :
There's data that supports your statement! If I look at young tech copanies, they all have a high PE ratio. If I go by the lower PE, I will end up investing in age-old tech companies that are going to decline and hence aren't investing in R&D at all!

Employee :
Let's close this PE chapter, I give up. But you can't deny the golden rule of buying and holding great companies! Plus if the management is good, plus the company has competitive advantages, it's a golden investment!

Senior Manager :
Sure, to manage a tech company, the management needs to be dynamic. If the management remains the same, good management goes bad overnight - because that's the nature of the tech business - the management needs to change and adapt quickly.

Fresher :
Oh, so the passive investing doesn't seem to work here. You need to revisit the investments on a regular basis to check if it still qualifies to be on the list!

Senior Manager :
Well yes, passive investig doesn't mean that you lose track of what you've invested in, too. Another argument is: companies paying dividends should be preferred - the earnings of a tech company are very volatile, so shouldn't be committed to paying dividends! Look at the data, the companies that pay dividends are those old aging companies. The younger ones always prefers to stay flexible by buying back stocks and investing profits.

Employee :
Okay. So how do tweak the valuation formulae and models to do all this?

Analyst :
Well, I think those formulas of intrinsic valuation should be abandoned. Do you remember what the last term in the intrinsic valuation implies?

Fresher :
The Gordon Growth? The D1/ke - g assumes the cash flows will come in perpetuity because the company is a going concern. The cash flows will grow at a constant rate (constant growth) and will be perpetual.

Analyst :
Yes. I can think of no tech companies lasting for perpetuity. Forget perpetuity, even something beyond two decades is exceptional by today's standards.

Fresher :
Okay, so in such a scenario, what should be done?

Analyst :
Well, the most conservative option is liquidation value. Tech companies have lower liquidation value. And it shall always be small as there are hardly any physical assets to sell. On the other hand, their intangible assets are valueless, too. That's what brings the companies down!

Senior Manager :
That's almost like not considering any terminal value. Isn't there any better way?

Analyst :
Well, something that most people don't do - that perpetual growth you saw warlier does not require a growth rate to be a positive number. Why not put a -10% growth rate?

Fresher :
Woah! What the heck will it do?

Analyst :
Shrinking in value will make your company smaller and smaller. In a few years, your company will disappear in books. That's the most realistic thing I could think of (only for tech companies, though).

Employee :
Doesn't make sense to me at all. You guys can continue with these unconventional approaches. I'll rather value each life stage of the company separately to get more accurate results.

Fresher :
Yeah! That makes more sense. All the best guys! Good bye. I'm on my own here.