Why Internet Stocks Are Getting Too Pricey, in Three Charts

Nov 11, 2013

Why Internet Stocks Are Getting Too Pricey, in Three Charts


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Internet stocks have gotten too pricey for Morgan Stanley‘sMS +2.21% liking. The investment firm on Monday lowered its view on Internet stocks to “in-line” from “attractive” amid valuation concerns. Morgan Stanley also eliminated GoogleGOOG -0.54% from its “Best Idea” list, although the firm kept its buy rating on the search giant. The call comes as Internet stocks have rallied sharply this year. Google topped $1,000 a share last month, Facebook Inc.FB -2.80% rebounded over the summer and currently trades well above its $38-a-share IPO price and Netflix Inc.NFLX +0.90% is up 262% this year, the second-best performing stock in the S&P 500.Twitter Inc.TWTR +3.00% went public last week and boasted a 73% pop in its trading debut, although shares slumped on Friday and are down again on Monday,

The Internet stocks that Morgan Stanley covers have risen 57% this year, compared to the 28% rally for the tech-heavy Nasdaq Composite.

“Outperformance has been driven by multiple expansion rather than positive estimate revisions,” Morgan Stanley analyst Scott Devitt wrote in a note to clients. “Consequently, we believe current valuations could be full despite strong secular trends.”

The sector either is “fully-valued, or that consensus growth expectations are too low,” Mr. Devitt said. “We believe that growth needs to accelerate to justify recent performance, the absence of which could lead the group multiple to revert to the mean.”

In the chart below, Mr. Devitt points to how several individual stocks have broadly outperformed relative to fiscal 2013 EBITDA estimates.

In the second chart, he notes the sector’s valuation has hovered above its mean dating back to at least January 2006, making it more susceptible of a short-term pullback.

“Multiple expansion at current levels…presents a more balanced risk-reward with reversions to the mean possible, absent a meaningful acceleration of growth estimates,” Mr. Devitt says.

And in the his final chart, Mr. Devitt says the trajectory of the Internet sector’s revenue multiple is approaching 2007 highs, another reason to be cautious for the near-term.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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