Another Dot Com Crash?

Hello, and welcome to another edition of Mr. Stillman's Opus. I'm John Stillman, joined today by a very special guest, Brian Evans. Brian's the founder of Madrona Financial Services in, well, not Seattle, but right outside Seattle.

What is it technically, Brian? Technically, it's in Bellevue, which is near Seattle, and Everett, Washington, which is north of Seattle. The home of the soaring real estate prices. Everything I've read is that Seattle is, you know, a few years away from being the new San Francisco in terms of real estate values.

Are you seeing that too? Yeah, particularly Seattle and Bellevue, the median home price is near a million right now, and there's a lot of old, dumpy houses there. So depending on where they're at, you can, yeah, the prices have gotten nuts. There's a lot of lakefront, obviously, they're in the three to 10 million, typically, area. There's just a lot of, yeah, there's been a significant amount of appreciation here, primarily due to the different businesses that are started and founded here, you know, your Microsofts and Amazons and Costco's and Boeing's and, you know, there's just Starbucks. There's just a lot of fabric of America type businesses that have taken off here creating a lot of new money that's just been ridiculous. So yeah, we've had a ton of highly appreciated real estate here.

I am yet to visit the Pacific Northwest, but I will one day. Well, I wanted to talk with you today, Brian, about the dot com crash. And by the way, Madrona Financial Services is one of the third party money managers that we use. A lot of our clients have money invested with Madrona Financial Services. Brian created three of his own ETFs, exchange traded funds. He has a domestic stock fund, international equities and a bond fund that he runs in house there at Madrona and is part of the portfolios that we've constructed there at Madrona.

But Brian, I wanted to talk with you today about the dot com crash and sort of the idea that, you know, we might be kind of flirting with a similar type of situation now. I was looking at some research recently that was illustrating how basically half of the growth in the S&P so far this year is attributed to only five stocks, Facebook, Amazon, Apple, Microsoft and Google. And of course the S&P is 500 stocks, right?

But half of the growth of that entire index is attributed to only those five companies. Well, it's a little bit similar to 99 2000 when the market was doing really well, but a lot of the growth was in just a couple of sectors. So kind of walk us through what happened, what caused the dot com crash and why was it actually avoidable? Yeah.

Um, there are similarities and there are differences in this one. And so the, the interesting thing, I did an extensive research on the dot com crash and it was not a crash of stocks, uh, across the board. What it was, it was a crash of a couple of sectors. And the, the problem was really, it had to do with market cap weighted investing. So what I mean by that is let's say you buy the S&P 500 or Vanguard index or any index, think of the term index. What the index does is it doesn't look at any companies, uh, internal financials or growth or profitability.

It doesn't look at anything. It just says, are you bigger? If you're bigger, we'll buy more of you bigger, meaning that other people are buying you. So it's kind of the, uh, just chase it as it goes up mentality. Now that works great when big companies are growing rapidly. So right now, indexes have been doing very well relative to other funds because of certain big names, as you just mentioned, are going up.

And so they just keep buying more of them and overloading on them. Now during the crash of 2000 through 2002 more stocks in the S&P 500 actually went up in value than down. Very few people know this, but the ones that went down is where most of the money was. And so when the dot coms telecom and technology shares dropped on average 80% they represented almost half of the money invested in the S&P 500 because of market cap weighted indexing. The indexes, the computers were buying the most of the biggest companies. So they had all their money basically in a small handful. And when that handful crashed, uh, it made the average of the index go down 40, 50% even though more companies went up in value than down. They just didn't have much money invested in those.

Pretty amazing. And I think you've backtested some portfolios where, you know, basically a truly diversified portfolio would have made not double digits, but would have made money during the dot com crash, right? Actually it would have made double digits. So what, what we did is we, we went back and said, okay, what, what kind of strategy would have worked? And, and lo and behold, it was Warren Buffett's strategy, uh, buy low based on what you're paying relative to the future profitability. And that's not that hard to come up with.

It's called the, if you look at price earnings ratios and growth of earnings and projections and, and analysts, you know, they're looking at this stuff all the time. So at the time you had all these dot coms. They had no product really. They had no, no plan for marketing. They didn't really have any, uh, uh, sales projections of any significance yet. They were worth $5 billion on the free market. Yeah. Well, stock, stock prices were going up simply based on the amount of web traffic that a site was getting.

Yeah, it was web traffic. And then you look at their financials and you'd say, all right, you're 5 billion. I remember looking at this one company, this guy called me and says, I'm thinking about buying this company.

So where'd you get the tip? He literally says garbage man. I said, what do they do? He said, I don't know, but they're dot com. Okay. Well, they're worth $5 billion on the market.

Yeah. I said their sales last year were a grand total of 1 million gross sales and their expenses were 20 million to produce 1 million. And the market thinks they're worth 5 billion. I say, I can't make sense of this, but there are other companies and we're other companies at the time where, uh, if they were worth $5 billion on the market, they were earning one and a half to $2 billion of profit annually.

Now that I can get my head around because that's earnings. That's you're going to replace the value of your company in the next three, four, five years. So it's these statistics that you can look back at and had you built a model, which we ended up building that said, we're going to rotate our money into the undervalued companies at all time knowing that, yeah, we won't get the run up when there's a panic buying going on, which occurred at the time. But in the end, uh, you know, like I said, Warren Buffett made a pretty good living off buying low and avoiding those bubbles. And so when everybody else is avoiding undervalued companies, he goes in there and buys a whole bunch of them. And lo and behold, later on you look back and go, well, that made sense. Well, that's what the funds are, you know, are designed to do that we were constructing to say, we always want to buy companies significantly undervalued when they're not, uh, the popular flavor of the day.

That's, that's the best time to buy them. Not, you know, is when they're not the flavor. Now you said there were similarities and differences in today's market compared to the time of the.com crash.

Let's take those one at a time. Primarily the similarities are what? Similarities are, uh, people get excited when they see something going up, up, up, up. So, uh, it is not a problem to talk somebody into, uh, the stock of a company that's up, you know, 300% in the last three years. But had we had that conversation three years ago and it had been flat, they go, well, I don't want to buy this. So the similarity is any bubble, uh, people get excited when prices are going up. Uh, the housing boom here, uh, you know, the, the million dollar 1200 square foot, uh, you know, 80 year old house, uh, people think, gosh, that's, that's a bargain.

Well, you know, a few years ago when it was 400 K, they didn't think it was a bargain. So we kind of get enamored by prices going up. So bubbles, uh, overvaluations. That's the similarity that I see in the markets. What's different about this market compared to 17 years ago. The big difference is that, as I mentioned with that $5 billion.com, uh, they had no chance of turning a profit. Uh, they were unprofitable companies. Now Google and Facebook and, and, uh, Apple are extremely profitable companies.

So that's the primary difference that their run may not be over if it's based on profits, but just because it may not be over doesn't mean that there aren't other companies out there that are undervalued with significant profits too. And so to help avoid a potential bubble in a sector, uh, rather than chase after something, it's already maybe kind of at a bubble or, or getting beyond fair evaluation. You might want to go after stocks in other sectors that have been being ignored all this time that are making very significant profits. And so that's the type type of diversification that I think is most important. It's not about buying, uh, uh, different sectors and, and different companies. It's about diversifying amongst undervalued companies in multiple sectors. That way, if we have a pullback like we did before, then you're really, uh, have a significant layer of protection because you're in other sectors that are all undervalued.

And that's generally where money floats to. Uh, people will sell overvalued companies to buy undervalued companies in whatever sector they may be in. So since the soaring stock prices of these companies like Amazon and Apple and Microsoft and Facebook are all based on actual profits of the company, I guess I'm hearing you say that you're not necessarily nervous about the future prospects of those companies, but still it's a bad idea to be overweighted in technology sectors like that.

It's AI. I think that it's not a great idea to be, to have all your eggs in any basket. Nobody foresaw, you know, it used to be that, uh, uh, if you wanted safe investment, you went into high dividend paying bank stocks. Well, we had a famous bank up here, Washington mutual, uh, had a lot of clients, a lot of money in that didn't want to diversify out. That didn't work out so good. Uh, then it was, uh, oil, uh, boy, just buy Chevron and an Exxon, you'll be fine. And then oil prices took a dive and all of a sudden you weren't fine. And so then it was, you know, it could be anything.

Oh, buy real estate. That never goes down. Right. And then we have a crash. So no matter what we think now, and now it's like, oh no technologies, you know, everybody's going to, it's just going to go up, up, up, up forever and ever and ever.

Well, I don't know of anything that ever has done that. And so it's just being prudent with your investment strategies that you don't just diversify stocks by saying, well, I'm diversified. I own Apple and Microsoft and Google and Facebook. That's why I'm diversified. I got four stocks.

Well, they're all kind of in the same, they're going to move similarly. And so, uh, being prudent about that, uh, you don't have to just take your money out of the market, but, uh, and put it into bonds, which I wouldn't recommend. I think there's a lot of great solutions outside of just buying bonds to reduce risk.

So one way to reduce risk certainly is to buy undervalued stocks when they're undervalued. Brian Evans, the founder of Madrona Financial Services, creator of three of his own ETFs and our guest today on Mr. Stillman's Opus. Brian, always good talking with you. Yeah, yeah.

I love this stuff. You, you were my introduction into the radio world and, and so I always appreciated you for that. Uh, now I have my own shows and now I can just talk all day long on, on, on the radio and, uh, come a long way. But, uh, you, you were the grand master of my, my original tutor for, for my introduction to radio. That was many years ago.

Yeah, it was. Always good to talk with you. And, uh, if you have any questions, certainly shoot us an email. We'll be happy to talk with you through some of these issues. And a lot of you listening to this, of course, already have your money invested at Madrona. So, uh, you know, you're already in good hands, but thanks for tuning in. We'll talk with you next time right here. Same time, same place on Mr. Stillman's Opus.