It’s a tricky time for the stock market. Recent gains and losses have worried investors as shown in the VIX index, a measure of market volatility, which is approaching an all time high. Perhaps no sector is as worrying as technology, which is seeing companies valued in the billions of dollars. Many investors are concerned that we are approaching a cyclical tech bubble like the one seen in 2000. Is it possible, or has technology evolved to justify valuations this time?
The fundamental value of a company is measured by current earnings and expected growth. A company with steady, increasing earnings in the tech sector is considered to have a valuation far exceeding that of other sectors like health care due to the potential for future growth. This is measured by a ratio called P/E, or Price/Earnings. Typically, in other sectors, this number hovers between 10 and 20, representing a stock price between 10 and 20 times the actual company’s earnings, but many tech stocks are seeing much higher P/E multiples.
Dot-Com Bubble Of The Past
In the Dot-Com bubble of 2000, tech stocks also saw inflated P/E ratios, but earnings did not live up to the hype. A perfect example is Juno, an Internet service provider offering dialup Internet service. The stock increased in value in the years leading up to the bubble while earnings were increasing. But in 1999, the company announced that it was going to switch from a paid service, with a fee of $15 a month, to a completely free service. The number of users skyrocketed as individuals dropped paid dialup services like America Online for the free service. Investors saw this as growth, and the stock value skyrocketed. Why? Because often, instead of considering that earnings would plummet, the investors were basing growth expectations on the number of eyeballs on the service.
Today, companies are often posting real earnings growth rather than simply user growth. And while some companies have P/E earnings of 100, for example, salesforce.com, these companies a) are also seeing widespread adoption, b) are frequently the industry leader in their niche, and c) show no signs of slowing down. Facebook, for example, is valued at between $60 and $100 billion, representing a P/E of about 200. And though Facebook’s earnings are only about $500 million, it has a unique position in the market as the world’s leading social network.
What Should You Do?
Many investors are recommending positions in tech stocks. Others are hedging their bets by buying some tech stocks and shorting (betting against) weaker companies. Many are staying out of the sector altogether. It’s likely that tech stock values will continue to rise, especially considering the overall undervalued nature of the market, even though P/E multiples in the tech sector seem like they set a very hard target to hit.
It’s hard to accurately assess whether the tech sector will live up to the expectations this time around, but for individuals working in the tech sector, avoiding tech stocks makes good financial sense. After all, in addition to the market capital in your 401k, you also have human capital in the form of a career that brings in regular earnings. Investing heavily in the tech sector is a failure to diversify your interests. If tech growth was to slow, your actual career might be at risk. Rather than losing your nest egg along with your career, diversify your interests by investing outside of tech so that one or the other grows, no matter what happens in the future.
September 11, 2011 at 3:23 pm
Rise and fall in stock exchange is a part of the business but business men are too sharp minded persons that can judge the flow of profit.
September 12, 2011 at 11:38 pm
Hey Naveed. Thanks for the comment.
I hope you are right! Hopefully these financiers are not just chasing the short-term profit. Don’t forget, the same VC’s and investment firms in the current sector were those that assured us in 2000 that tech was a sure bet before the bubble bust. And, Wall Street didn’t do too good of a job in their valuation of the housing market circa 2008. My trust runs thing.
September 13, 2011 at 6:20 am
stock exchangers are so true minded that they often brings stock market down due to their benefits and some times gives it boost by investing millions. great post
September 13, 2011 at 6:01 pm
Thanks for the comment Reeha. I can’t agree with you more. The only caveat being the traders do serve as an extremely valuable asset to our economy: they add liquidity to the market that otherwise would lack the assets to grow.
September 13, 2011 at 4:30 pm
Well.. Business men are certainly not gamblers.. they only take medium risk.. but what is proposed here is certainly about taking the lowest risk.. a little stepping out of the comfort zone might be a good idea.. 😉
September 13, 2011 at 4:49 pm
Hey Kevin. I like your thing here. A balanced portfolio with defined amounts of risk is definitely the best approach. My article sides with caution for those employed in the tech sector, such as myself. As an Internet Marketer, if the bubble pops and the companies that empoly my services no longer exist, I’m screwed. But, my personal wealth does not have to suffer. Since I employ my human capital in the tech sector, I should (and do) only employ a limited amount of my financial capital in the tech sector: preferably something complementary to tech. For those of you who do not have something at stake in tech, I suggest you diversify your portfolio, invest in the growing tech market, but make sure you are partially hedged for a possible bust!
September 16, 2011 at 6:50 am
The tech-sector always brings extra risks. It can be very unpredictable because of new innovations, or the lack there of.
I am positive that Facebook is sitting on a bubble.
Those validations companies like that get are almost totally based on assumptions. Of course there are assumptions or predictions that will most probably be right, but you never know what/who steps out of the corner.
What if by some miracle Google+ takes the social-networking by storm, taking a big bite out of twitter and facebook. Then that p/e of 200 is going to plummet.
September 20, 2011 at 12:48 am
Sandra, thank you for the comment. You make an awesome point. If we could predict the future with 100% accuracy, then I guess we’d be RICH! Who knows what will happen, let’s just hope it is the best outcome for the greatest number of people.
September 17, 2011 at 5:08 pm
Stock exchange is a place from where business men take business indicators.Most of the business are too expert that their predication about stock exchange always prove true.They thinks business risks are the part of their profession but they never loose heart.
September 20, 2011 at 12:50 am
Thanks for the comment Shani. Great point, traders are always in a battle of head vs. heart. Maybe they feel that something are likely overvalued, but the numbers and indicators say they can make a lot of money.
January 21, 2013 at 8:01 pm
Technology stocks go up and down. They are one type of stock traders buy and sell when economy goes up a down. I would rather own diviend paying stocks they move up and down less and you create a income from them over time. Look at apple stock it is down a lot now so i do not like tech stocks that much.
March 13, 2013 at 7:11 pm
I’m just like you. I crave the good things in life. And while money can’t buy happiness, it sure can buy everything else! Who wouldn’t want a million dollar home, or their kid’s college education paid for? Sure…a Volkswagen is nice, but isn’t a Mercedes or BMW even better? I’m confident that with enough money in the bank I could finally take more than one vacation a year, or have enough to put away for retirement. And more importantly, have the means to pay off multiple credit card debts, school loans, and medical bills.
April 2, 2013 at 4:01 am
I guess there would always be ‘bursts’ every time an industry gets saturated, regardless of its nature. With more and more online companies coming out and having a big break like Facebook, Instagram, Pinterest, etc, I don’t see any form of slowing down. Of course, there is the fate of Groupon, and other related companies who did not do well, but the key is innovation, and a well-thought one. I would liken this to my BMW320d, which I bought a couple of years back, but because of lack of foresight I guess from BMW, they did not really see how swirl flaps could affect and damage the engine. Even though there is innovation on BMW’s part, it was not completely well thought. Thus, this lead me to sell it, forego it and make the switch. At some point, BMW was praised for its 320D, but eventually, it contributed to loss of confidence for a while because of this design abomination, yet, it was able to recover confidence from the market with its future models, with better and innovative design, inside and out.