Irrational tech exuberance, anyone?
By MATHEW INGRAM
Globe and Mail Update
Remember the bad old days of the tech-stock bubble? Stocks traded at enormous multiples of revenue and earnings, based on unreasonably optimistic views of the future. We're so much smarter now, aren't we? We've learned our lesson — not to push stocks up so high without some evidence that their growth rate justifies a high multiple. So now we're only paying 70 or 80 times projected profits for Amazon and eBay and Yahoo, instead of 100 or 200 times.
It's not just those Internet all-stars either. Apple is trading at 85 times this year's estimated earnings. Even after tumbling by as much as 10 per cent on Friday, Applied Materials is selling for 60 times projected profit. Advanced Micro Devices is at 64 times next year's estimates (it is expected to lose money this year) and Juniper Networks is 175 times this year's estimated profit. Amazon is about 72 times, Yahoo is about 62 times and eBay is 57 times.
Relax, analysts say. Stock prices, particularly for volatile tech companies, are frequently depressed in what they call the "trough" of an economic or market downturn. Once the market and the economy recover, those sky-high multiples inevitably shrink as profits increase. The only problem with that, of course, is that it assumes the market is on its way back to strong growth.
In any case, the multiples on next year's estimates aren't much better. Yahoo is selling for 45 times next year's profit, Amazon is also at 45 times projected earnings, eBay is selling for 44 times estimates and Apple is at 43 times. As mentioned, Advanced Micro Devices is at about 64 times next year's estimates, and Applied Materials is selling for 22 times. Are any of these companies growing at rates that might justify those kinds of figures? Only one: eBay.
The on-line auction firm, whose business model is based entirely on playing a low-cost, middleman type of role for buyers and sellers, is growing at triple-digit rates and has been for some time. When you turn in a quarter like eBay just did, with cash flow up over 120 per cent, revenue up 170 per cent, and so on, then perhaps your stock is worth 57 times this year's estimated earnings and 44 times next year's. If you are hoping to grow profits at closer to single digits, as Amazon and Yahoo are, then such a multiple is a hard to fathom.
And let's keep in mind that most of those earnings targets — primarily from Thomson Financial/First Call — are also based on that most beloved of tech-stock benchmarks, "pro forma" income, otherwise known as EBATBS or "earnings before all the bad stuff." Amazon, for example, got all kinds of credit for making a profit of 19 cents (U.S.) a share in the fourth quarter, but when it comes to actual net income the company made 1 cent rather than 19 cents.
Obviously, not all tech stocks are trading at 70 or 80 times earnings — companies such as Cisco, Dell, Intel and Oracle are in the 20 to 30 times range. But are the multiples they are selling for that much more reasonable? Not really. Take Cisco. The stock is trading at about 25 times this year's projected profit and 24 times next year's, and yet the company is expected to grow by less than 10 per cent this year and perhaps slightly more next year.
Dell is another good example of an excellent company whose stock has probably gotten too high for its current growth rate. Although Dell has been winning the market share war for some time now, taking customers away from Hewlett-Packard, IBM and Gateway, that has taken its toll on profit margins, and while it has kept Dell growing faster than the PC business itself, there are doubts about how much longer it can keep that up. Should Dell trade for 30 times earnings when the industry as a whole is growing at 5 per cent or 6 per cent at best?
Intel, meanwhile, is by far the leader in microprocessors, but at the same time the company's profit margins have been squeezed until they are razor thin. Most analysts say it will be lucky to grow at 15 per cent in the next year. Chip maker Analog Devices is also trading at 30 times this year's estimates, despite the fact that there is no sign of a pickup in demand that would justify such a price — as evidenced by the fact that Intel is cutting spending.
The list goes on. Apple has shown little reason why it should be trading at more than 40 times next year's earnings, and Oracle is selling for 30 times earnings even though its growth rate this year is expected to be 5 per cent to 7 per cent at best, and possibly even lower next year. Do those kinds of numbers make you nervous? They should — unless, of course, next year is going to see a boom in technology spending that will cause profits to soar at these firms.
It could happen. Then again, this year could wind up looking a lot like last year in terms of spending, in which case some of those stocks are still going to look like they're up in the stratosphere.
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