Will Tech Valuations Burst Like the Dot-Com Bubble?
If you've been following the stunning market debuts of companies like Twitter and other tech superstars, you might have a bad case of valuation envy.
After all, if such young technology companies can rack up crazy stock prices far in excess of their worth, why can't your business?
Janus's monthly equities report for November might put your mind at rest, while simultaneously raising some alarms. The report points out that after years of chasing companies that have yielded lackluster returns, retail investors are now latching onto social media or cloud-computing IPOs, which have stories these investors can easily understand.
But, the report warns, "cloud computing and social media are bringing a level of disruption and innovation not seen in the technology sector since the dot-com era," and "the troubling aspect is that valuations for many of these companies seem just as stretched as Internet stocks were back then."
Janus should know what it's talking about, as the purveyor of some of the most high-flying tech stock funds in the run-up to the burst of the dot-com bubble in 2000.
Profits Aren't the Whole Story
So what is Janus talking about now?
Let's take a closer look at Twitter. The social media company's shares nearly doubled on the first day of trading on November 15. It has a market cap of about $22 billion today, even though it hasn't turned a dime of profit. It's actually lost hundreds of millions of dollars over the past few years.
Despite that, Twitter's price-to-share ratio, which is one way to gauge a company's value, is somewhere around 70. By contrast, competitor Facebook, which is profitable, has a price-to-share ratio of 21. Stalwart tech stock Google has a ratio of just 2. Generally, the lower the number, the safer the investment is considered to be, although that can vary widely from industry to industry.
Similarly, stock prices for many companies associated with cloud services, such as Salesforce.com, are up 30 percent to 40 percent or more since the beginning of 2013.
The stretched valuations are not limited to businesses that have gone public either, the Janus report goes on to say. Companies with negative earnings on the Russell mid-cap index grew 48 percent in 2013, compared to 25 percent for the entire index.
"Many of those companies with negative earnings are associated with the hyper-growth industries that have been in favor," the report says. "These companies would need truly exceptional multiyear performance to get the type of revenue growth and margin expansion to justify the valuations."
Many, though not all of these companies, will stumble and fall in the coming years, the report warns.