published Wednesday, October 30th, 2013

Personal Finance: Are tech stocks getting too high?

Chris Hopkins

It seems like only yesterday that we were seeking to rationalize the excessive valuations of tech stocks as the market surged toward its early 2000 highs. Many of the high-fliers generated little or no profit, but the allure of the next big thing proved irresistible. Then in March of 2000, the Internet bubble popped. While the traditional blue chip indices have since reached new all-time highs, the NASDAQ composite still languishes more than 20 percent below its record level of 13 years ago.

Clearly, we are not in the throes of another mindless mania on the scale of the 1990s. But there are definitely echoes of the old siren song in the current run-up of some tech stocks that should serve as a cautionary sign.

Amazon is an old friend from the last episode, and the game plan today is similar: continue expanding on the assumption that it can pivot toward making a profit once it sufficiently dominates the sectors in which it plays. The company carries a stock market value of $166 billion, about the same size as Coca-Cola and two-thirds as big as Walmart. But Amazon doesn’t generate much of a profit, the mother’s milk of stock appreciation over the long run. Coke trades at around 18 times next year’s projected earnings; Walmart at 13 times. Amazon stock sells for 130 times expected profits for next year, if indeed it is able to eke out any profit at all. While there is no doubt that the company has had tremendous success at expanding its customer base and staking out new territory, investors will eventually turn their attention to a return on investment.

Facebook has recovered from a bungled IPO last year to attain a record stock price, thanks to some evidence of better ad penetration on mobile devices. However, it trades at 52 times next year’s earnings. Analysts are predicting 30 percent earnings growth per year over the next 5 years, which would bring the multiple back to earth. But the social media company already counts approximately one fifth of the world’s population ages 15 to 75 as subscribers. Is there really room for that much growth ahead? And what guarantees that Facebook remains as cool next year? Remember Myspace?

Netflix carries a forward P/E multiple of 82, Tesla trades at 168 times, and Zynga can’t even compute a P/E since they lose money. While it is certainly difficult to value these revolutionary companies with traditional metrics, it is still the case that they must eventually settle into a more predictable (and profitable) groove or shareholders will lose interest. As we have observed at the end of all bubbles, this can happen quite suddenly and inflict a lot of damage on investors who hesitate to get out or hopefully hang on for their picks to recover. Some of these companies will thrive, but many will not.

For investors with a reasonably long time horizon and a decent tolerance for risk, some limited exposure to these potentially disruptive tech stocks is certainly appropriate. But for most average investors, betting heavily on story stocks that can’t be evaluated with traditional financial metrics can be akin to taking a ride to Vegas. Arrive in a $30,000 car; return home on a $300,000 bus.

Christopher A. Hopkins, CFA, is a vice president for Barnett & Co. Investments. If you have personal finance questions for Chris to answer, send them to buisness@timesfreepress.com

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