Tuesday, 29 May 2012

Are We in Another Dot Com Bubble?

The immediate slide in Facebook's share price since its much-hyped IPO begs the question: Are we in the midst of a second Dot Com bubble?  There is no widespread tech-driven mania, as there was in the late-1990s.  In those heady days, virtually any company with a ".com" at the end of its name went to the sky.  Indeed, several companies changed their name by adding that very suffix (or similar ones) only to see their stock price soar instantly.  Businesses based on questionable (or worse) premises commanded multi-billion dollar market values, such as Pets.com, the infamous online seller of cat food and dog kibble.  The internet has been a feature of mainstream life in most parts of the world for 15 years or so.  Though it has been every bit as revolutionary for society as expected, it's now understood that it's not a license to print money for anybody and everybody that uses it.
However, among social networking stocks, in some "cloud" computing companies, and scattered here and there in the tech space, valuations are sometimes approaching the nose-bleed heights of the late-1990s.  As noted at length in an earlier article, Facebook's IPO price assumed very strong growth rates over a prolonged period of time.  Related stock Zynga, which provides many of the games that Facebook addicts enjoy, currently sells at a price that values the company at $4.5 billion.  Granted, the company has nearly $1.8 billion in cash and investments, and sales grew 90% from 2010 to 2011.  However, sales growth slowed significantly in the first quarter of 2012 compared to the year-ago period.  Most importantly, the company incurred a large loss of $404 million in 2011, and an $85 million deficit in Q1 2012.
LinkedIn, the widely-used professional networking site, has a stock price of nearly $100, valuing the company at over $10 billion.  Sales growth has been impressive over the past few years, more than doubling to $522 million in 2011, and doubling again in the first quarter of 2012 compared to the same period a year earlier.  Earnings, however, remain virtually non-existent.  Indeed, income stood at $11.9 million in 2011, down from $15.4 million in 2010, and grew to a not-so-impressive $4.9 million in the first quarter of 2012.  Given that sales have galloped forward, it's worrisome that earnings haven't done the same.  Whatever the company earns this year, its multiple is likely a three-figure one at today's stock price.
When bargain-hunting investors scan P/E ratios, the only thing worse than a high multiple is an "NA," which denotes a company that doesn't generate earnings at all.  In the "cloud" space, Salesforce.com's 2011 performance put the company in the unprofitable "Not Applicable" category.  As are many other tech firms, the company is posting impressive sales growth.  Between fiscal 2008 and 2012, revenue grew by 32% per year, and that figure grew by 38% in the first quarter of this year compared to last year's first quarter.  However, none of this growth is making its way to the bottom line.  In fact, the company is forecasting a loss of 0.45 to 0.48 cents for fiscal 2013.  By contrast, the shares trade at around $145, which values the company at about $20 billion.
Groupon went public last year at a price that valued the company at nearly $17 billion, before the company had established profitability.  The stock has fallen sharply, from around $26 at IPO to under $12 today.  Even tech bellwether Amazon.com, a familiar company with a straightforward business model, commands a very high multiple.  The company believes that establishing a market presence today will lead to profits down the road, and it views sub-par profits in the near-term as a kind of investment.  The strategy, in fairness, has worked for the company over time, and it's undeniably dominant in many areas.  However, investors ought to be skeptical of some of Amazon's cutting edge peers, who have taken the same relaxed stance on current profitability: after all, there's no guarantee that tomorrow will be better than today.

For coverage financial bubbles read my review of John Kenneth Galbraith's A Short History of Financial Euphoria

Disclosure: The author did not own any positions, long or short, in any of the companies mentioned at the time this article was published.
Sources: Official filings that can be found on the respective companies' websites.
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