The Scottish Mortgage share price keeps falling. Should I buy?

The Scottish Mortgage share price has collapsed from its all-time high in little more than six months. Is it now a no-brainer bargain?

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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?

Rich rating

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.

De-rating risk

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.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

G A Chester has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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