Steve Ballmer's Bunk

Steve Ballmer's Bunk

Steve Ballmer's Bunk

Moneybox
Commentary about business and finance.
Sept. 27 1999 9:20 PM

Steve Ballmer's Bunk

Steve Ballmer spoke, and the stock market trembled. Too bad it didn't yawn.

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Ballmer is president of Microsoft (which, incidentally--well, I hope just incidentally, since I sure do like my job--owns Slate), and last Thursday, in a post-speech question-and-answer period, he told the Society of American Business Editors and Writers that the stock market's valuation of "technology stocks," including Microsoft, was "absurd." Ballmer's comments almost singlehandedly drove the tech-heavy Nasdaq--"tech-heavy" is an adjective permanently attached to "Nasdaq"--to its worst performance in five months and sent Microsoft's shares (which, full disclosure, I own) down 5 percent.

As just about everyone has remarked, Ballmer's comments were nothing new. Microsoft's CFO, Greg Maffei, told analysts this summer that the company's stock valuation was "ludicrous," and Ballmer told those same analysts that investors' expectations for Microsoft's future growth were "outlandish." Microsoft execs in general are well-known for downplaying the company's future prospects. Bill Gates himself supposedly told his father to sell his Microsoft stock soon after the company went public and saw its shares soar to what then must have seemed like stratospheric levels. (Sensibly, Gates' dad declined the advice.)

Ballmer also has a clear incentive to talk down Microsoft's stock price, at least in the short term. A higher stock price makes it more difficult to lure employees with stock options, and, more important, makes existing options more expensive. And keeping investor expectations moderate is a good way of making sure you meet those expectations.

But even if Ballmer's comments had been completely unexpected and completely unrelated to any of Microsoft's broader corporate goals, they should not have moved the market, because Steve Ballmer knows less about the appropriate valuation of technology stocks than the market does.

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The value of a company depends essentially on two things: the free cash flow (cash above and beyond expenses, including its cost of capital, and reinvestment) that the company generates and the length of time the company is able to continue generating free cash flow. In valuing companies like Microsoft, Cisco (which I also own shares of), Intel, and Dell so highly, then the market is saying two things: These companies are generating extraordinary amounts of free cash flow (which they are), and they will be able to continue generating that kind of cash for a considerable length of time.

Now, the first point is not really arguable. By any meaningful measure of economic performance, the dominant U.S. technology companies today are among the most successful and profitable in the history of the world. (I say that for effect, but I'm not exaggerating.) The second point, which has to do with the sustainability of this domination, is presumably the one Ballmer finds so objectionable. With technology changing as rapidly as it seems to be, Ballmer is arguing, no company can really be sure of staying on top for a long time.

Now, I think Ballmer is wrong about these valuations, which is to say wrong about the future. (That's why I own shares in some of these companies.) Now, the fact that I think Ballmer is wrong is basically irrelevant (except, perhaps, to my future here). The fact that the market thinks Ballmer is wrong is, however, very important.

Our natural inclination, after all, is to imagine that someone in Steve Ballmer's position must know a lot more than everybody else about something like the valuation of technology stocks. But to succumb to that inclination is to reject the most important lesson taught by the triumph of capitalism, which is that markets process information, judge the future, and allocate capital far more efficiently and successfully than any individual, no matter how well-positioned, possibly can. We don't trust central planners anymore because we know they can never know as much as or react as quickly as markets can. And we shouldn't dump our Microsoft stock because Steve Ballmer says it's too expensive for the very same reason.