The Scottish Mortgage (LSE: SMT) share price closed below 700p earlier this week, for the first time in over two years. This left the shares down 40% over the last 12 months and 55% below their all-time high of November. Clearly, many investors have deserted what was, until recently, a hugely popular investment trust.
I like Scottish Mortgage’s long-term investment philosophy and admire a lot of the businesses in its portfolio. However, I’ve previously been uneasy about the valuations of the trust and its underlying holdings. After the slump in the share price, should I now buy?
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Let me bullet-point my previous concerns about valuation:
• The price-to-sales (P/S) ratio of the US Nasdaq index, in which Scottish Mortgage does a lot of fishing, had soared from 1.02 to 4.35 over the previous 10 years. The average P/S of the trust’s top holdings was 9.2, suggesting it owned some of the most richly rated companies in a richly rated market.
• Scottish Mortgage had reached an extraordinarily high ranking in the FTSE 100 — comfortably in the top half. Such a ranking for a generalist investment trust was unique in the index’s 36-year history. Only a few trusts had ever even made it into the top index. And none had retained their place.
I felt that a decade of unprecedented stimulus by central banks, producing momentum-driven markets — “don’t fight the Fed, buy what’s going up” — may have produced a big disconnect between price and fundamental value.
On this view, I saw considerable risk of a future de-rating of Scottish Mortgage’s heroically-valued holdings and therefore of the trust itself.
Given the collapse of the share price over the last six months or so, it may look like I made a prescient call. However, there’s one thing I haven’t yet mentioned.
Back to square one
At the time I expressed my valuation concerns, Scottish Mortgage’s share price was 755p. In other words, not much above where the price is today. The P/S ratio of the Nasdaq today (4.25) and the average P/S of Scottish Mortgage’s top holdings (9.3) are also much the same.
However, the fact is that, in between times, the trust’s share price reached highs of over 1,500p. Was I wrong to shun the stock at 755p in the past? And should I now buy it at a similar level today?
Scottish Mortgage’s cut-rate share price
One thing I’ve learnt over the years is never to underestimate how far irrational exuberance among investors can inflate speculative bubbles. I could be wrong, but I think the rise in Scottish Mortgage’s share price to over 1,500p was a product of irrational exuberance.
However, even if I’m right on that, what about at today’s price of less than half the peak? Well, when the price was 755p, I reckoned that to buy in, I’d have to believe in a new valuation paradigm. Namely, that P/S ratios of maybe 5-10 for indexes like the Nasdaq would become a new normal, fairly reflecting the fundamental value of the businesses.
I remain unconvinced by that proposition. I could be missing a big opportunity, if I’m wrong, but I’m not tempted to buy Scottish Mortgage at today’s share price.