Talk of a tech bubble has percolated in the past few weeks, and a July 3 computer glitch that incorrectly showed tech company stock prices crashing didn’t help. Tech investors were already on edge after a Goldman Sachs report prompted some of the hottest tech stocks to tumble in June. The investment banking company warned of “a valuation bubble,” which left many investors wondering if they owned too many shares of tech titans such as Facebook (ticker: FB), Apple ( AAPL), Amazon.com ( AMZN), Alphabet ( GOOGL, GOOG) and Microsoft Corp. ( MSFT). These heavy hitters have helped drive higher returns for both the Standard & Poor’s 500 index and the Nasdaq this year.
Although the report stopped short of predicting a tech bubble, some investors wonder if the stratospheric valuations in the tech sector are a precursor to another dot-com crash like the one in 2000.
That’s not likely, says Matt Maley, managing director and equity strategist at Miller Tabak & Co. in Newton, Massachusetts. “I don’t believe we are near a tech bubble,” Maley says. “It’s not the same as 2000. But that doesn’t mean they aren’t overvalued.”
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What makes this time different is that Apple and many major tech titans, such as the FANG stocks (Facebook, Amazon, Netflix ( NFLX) and Google parent Alphabet), have intrinsic value, says Christopher Mirabile, managing director at Launchpad Venture Group and chair of Angel Capital Association in Newton, Massachusetts.
Many of the tech companies in the 2000 dot-com crash were initial public offerings, with unproven business models and “no underlying value,” Mirabile says. “They were cranked out by venture capitalists and investment bankers, prematurely doing IPOs and getting dumped on Wall Street.”
That’s not the case with today’s heavy hitters, he says, which are all established, profitable companies. Amazon can drop a billion dollars to its bottom line just to “shut up the analysts,” while Alphabet, like Apple, generates billions in free cash flow. Along with strong management teams, today’s tech giants are aggressively pursuing data center operations and lead the development of cloud technologies. The reason these companies may be overvalued, Mirabile says, is because few better alternatives exist.
With more companies staying private longer, venture capitalists aren’t “pushing crappy companies to go public” as they did with anything that “had internet in its name in 1999,” Mirabile says. Instead, much of the growth and value in today’s tech companies happens before their IPO, he says.
“By the time they go public, they are very solid established companies. They are good investments, but their insane growth gains are usually behind them,” he says.
That’s a mixed benefit for tech investors, so even if they aren’t prepared to curb their enthusiasm, they may at least want to hedge their bets.
Take some profits. For investors who purchased a mega-cap tech stock two or three years ago, Maley suggests selling some of those gains. For example, if you bought Nvidia ( NVDA) more than 18 months ago, the stock has since appreciated 500 percent. By selling only 20 percent of the shares you own, you’ll get every penny you initially invested while still owning enough stock in the company to benefit from further growth, he says. What investors shouldn’t do, he says, is buy or sell everything all at once.
“People worry if they’ll miss some of the upside,” Maley says. “With some huge gains, it’s OK to leave a little money on the table if it locks in your initial investment.”
But many investors make the mistake of selling too early or too late.
“If you sell gradually, especially with the big gainers, you’ll usually more than double your profits, and you’ve cut your losses to zero because you’ve managed your gains,” he says.
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Know the risks. For everyday investors who don’t know much about the tech industry, trying to pick the next winner is risky, if not impossible. That’s why Mirabile says investing in an inexpensive tech sector index fund, such as the Vanguard Information Technology Index Fund ( VITAX), may be better.
Investors who prefer buying company stock should separate their enthusiasm for the tech innovation from what the laws of economics say about a company’s prospects, says Alec Lucas, senior analyst in manager research at Morningstar in Chicago.
The bigger a company gets the harder it is to maintain an above-average growth rate, Lucas says, although globalization can provide companies with new opportunities. For example, he says, Google and Facebook are capitalizing on India, where both mobile use and the country’s population are growing.
But investors, he says, should balance any assumptions about growth potential with an understanding of the risk tech companies face. Those risks include hefty penalties for anti-trust violations, such as the record $2.7 billion fine the EU imposed on Google. As the Trump administration rethinks U.S. regulations on immigration, treaties and tariffs, tech companies that do a lot of business abroad could get caught in the crossfire, given the unpredictability of international relations.
“There is still money to be made in tech innovation with some of these standard stocks,” Lucas says. “But investors need to be cautious.”
Be discerning about value. While most stocks trade on forward expectations of earnings for the next year, Lucas suggests that investors also pay attention to the more conservative measure of a company’s value — its price relative to its earnings over the preceding year. Then compare that trailing price-to-earnings ratio with the S&P 500’s trailing, one-year P/E. As of mid-2017, it was about $21 per share, which means an investor pays $21 for $1 of earnings. For some of tech’s biggest names, the trailing P/E for the past 12 months was as follows: Netflix $211.78, Amazon $187.31, Facebook $38.54, Alphabet $33.39 and Apple $17.80.
One of the best times to invest in a large tech company is when many investors are overly pessimistic about it because of bad press, Lucas says. That was the case for Samsung Electronics Co., after its phones made headlines for catching on fire and its CEO was jailed on corruption charges. “It can be an attractive entry point when a company is mired in scandal,” Lucas says. “As long as you don’t think the company is going to go bankrupt.”
Consider the big picture. The tech sector also faces the same general market risks as other sectors now that the Federal Reserve wants to begin unwinding its balance sheet, Maley says. Since 2008, the Fed has been pumping cash into the economy by purchasing Treasury bonds and mortgage-backed securities. As the Fed shrinks its balance sheet and raises interest rates, growth in the stock market will be harder to come by, even for tech stocks, Maley says.
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“It’s been a long time since we’ve had a correction in the market,” he says. “As painful as they are, corrections are normal and healthy.”
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Should Tech Investors Curb Their Enthusiasm? originally appeared on usnews.com
