Tech Stocks Are Still ‘Too Silly’ for Some; Valuations of Young Tech Companies Remain Sky-High

Tech Stocks Are Still ‘Too Silly’ for Some

Valuations of Young Tech Companies Remain Sky-High

STEVEN RUSSOLILLO and MATT JARZEMSKY

May 11, 2014 4:23 p.m. ET

Young technology-company stocks fell out of favor in the blink of an eye. But their valuations remain sky-high and many investors say they have a lot more room to decline before bouncing back. Steven Russolillo joins MoneyBeat. Photo: AP.

Young technology-company stocks fell out of favor in the blink of an eye. But their valuations remain sky-high and many investors say they have a lot more room to decline before bouncing back.

Cybersecurity firm FireEye Inc. FEYE +7.68% has tumbled 72% from its peak March 5, the day the tech-heavy Nasdaq Composite Index hit a 14-year high. Meanwhile, advertising-technology firm Rocket Fuel Inc. FUEL -1.40% is down 61%, software firm Splunk Inc. SPLK +2.95% is off 50%, microblogging serviceTwitter Inc. TWTR +4.90% is down 41% and electric-car maker Tesla Motors Inc.TSLA +1.28% is off 28%.

 

The selloff began abruptly in early March, with traders saying there was no single reason sparking the collapse. The losses have been concentrated in what had been the market’s hottest names, particularly Internet, social-media and biotech stocks.

Money managers say it is no mystery what has been at work: These stocks rose to stratospheric prices compared with their earnings outlooks, driven by so-called momentum traders such as hedge funds that pile into rising shares. But these firms were equally quick to hit the sell button.

Now, many investors say valuations are still so rich that further declines are still in store. Tesla trades at 89 times next year’s earnings, according to FactSet. That is down from a price-to-earnings multiple of 117 in March, but still about six times more expensive than the S&P 500. Daily-deals site Groupon Inc. GRPN +0.84%trades at 35 times next year’s earnings.

“We’ve gone from three times silly to two times silly,” said Mitch Rubin, chief investment officer at RiverPark Funds, which has $3.1 billion under management. As investors start focusing more on the fundamentals of these stocks, they could easily fall further, he said. “When the facts start to matter for these stocks, the bottom is a long way off.”

Mr. Rubin has been betting that shares of Amazon.com Inc. AMZN +2.66% and Twitter would fall. Just last week, he placed bets that some stocks already down 40% would extend their slide, he said.

Riskier corners of the market have taken a bruising. The Russell 2000 index of small-capitalization stocks last week briefly dropped 10% from its recent peak. The Russell 2000 Growth index, home to many of the small fast-growing companies that have taken a hit lately, is down 7.1% so far this year.

But broader indexes have weathered the storm. The Dow Jones Industrial Average closed Friday at a record, its second of the year. The Russell 1000 Value Index, which tracks large stocks that generally grow at a slow pace and pay dividends, is up 2.8% this year.

Behind the rally that lifted these momentum stocks to lofty valuations was a hunger among investors for fast earnings growth at a time when the global economy is stuck in slow motion. S&P 500 companies are on pace to report first-quarter profits that are 2.2% higher than they were a year ago, according to FactSet.

“The challenge these stocks are going to face is who is the buyer here that steps in now that the bloom is off the rose,” said Michael Church, president of Philadelphia-based Addison Capital, which has about $550 million under management.

The declines in these momentum stocks have been sharp and swift. Twitter slumped 21% over a two-day span last week after the expiration of a lockup period that prevented the company’s early investors and employees from selling shares.

The company still trades at 285 times next year’s forecast earnings. While that is down from a price-to-earnings ratio of 1,154 in early March, it is still considerably more than the S&P 500, which trades at 15.2 times coming earnings, FactSet says.

“You can’t go to Warren Buffett and say, ‘Buy Twitter, it’s cheap,'” said Seth Setrakian, co-head of domestic equities at brokerage firm First New York Securities. “He’d slap you.”

To be sure, some buyers are stepping in on some of these beaten-down stocks. Jamie Cox, managing partner at Harris Financial Group, a financial-services firm in Richmond, Va., that manages money primarily for retirees, said he took a small position in Twitter days after the company’s quarterly report on April 29.

“I could never justify Twitter in the $70s, but I could justify buying the stock at these levels,” he said. “It’s ok to overpay for it right now because the potential for what it can do is worth the chance.”

Other stocks are also stuck in this purgatory. LinkedIn Corp. LNKD +2.11% trades at a multiple of 74 times next year’s expected earnings, Netflix Inc. NFLX +3.77%at 63.3 and Facebook Inc. FB +3.39% at 36.5, according to FactSet.

Amazon has traded at high valuations for years, as investors credited the firm for its practice of investing its money in warehouses and computer power instead of booking profits.

But Amazon investors have been rethinking that premise in the wake of the last two earnings reports, which showed strong revenue growth and skimpy earnings. After peaking above $400 in January, the stock has lost 28%.

John Thompson, founder and chief executive of Chicago hedge fund Vilas Capital Mangement LLC, bets against stocks he sees as overvalued and buys those he deems cheap. Reflecting the extreme disconnect between those parts of the market, he said, the stocks he is betting against, or shorting, have an average forward P/E ratio of about 210 times, versus the 10-times P/E ratio of stocks he is betting on.

“The high-growth, high-momentum stocks are more overvalued than Cisco andQualcomm QCOM +0.47% and EMC and things like that were in 1999,” he said. “The value part of the market is far cheaper now than it was in 1999 as well.”

 

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.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

<span>%d</span> bloggers like this: