During an appearance on the Fox Business Channel‘s Varney & Co. on Thursday, (you can see it below) host Stuart Varney asked me point blank if I was worried about what’s ahead for tech stocks.
You can certainly understand why he’d ask such a question. The health of the U.S. economy continues to be a real worry for many and the growing political mess we know as Washington can only make matters worse.
Against that troubling backdrop the tech-focused Nasdaq Composite Index is up 31% so far this year and 207% from its financial crisis lows of March 2009 – returns that handily trump the respective 22% and 142% gains of the record-setting Dow Jones Industrial Average.
Whispers of “another tech bubble” and “another dot-bomb implosion” have been getting louder, and the excellent and the always-probing Varney wanted to know if I was worried – or perhaps even bearish.
Let me say to you what I said to the Fox viewers.
If you’re running away from the technology sector right now, you’re making the biggest mistake of your investment career.
And in today’s Strategic Tech Investor, I’m going to show you why …
Back in June, tech-sector analysts and other market pundits were growing fearful. The tech sector had been on a healthy run, and they were worried that in the face of a wheezing economic recovery the rally in biotechs, social-media and digital-technology stocks just couldn’t continue.
But in a late-June talk here, I told you to expect a big second half of the year for all of those sectors.
And that’s just how it’s played out.
Since that time, the Nasdaq has zoomed 16.6% – more than twice the 7.4% gain of the Dow.
Five months later, the tendrils of worry about tech stocks have returned.
In a story earlier this week, MarketWatch.com suggested that tech stocks have entered into bubble territory. And while the story used such loaded terms as “froth” and “exuberance” – and made veiled references to the dot.com mania of 1999 and 2000 – the reality is that the so-called “facts” that served as its foundation were thin at best.
This wasn’t the first story to talk about a tech bubble. Unfortunately, it also wasn’t the last: As this week has progressed, so has the tech-bubble patter.
So let me cut to the chase and bust this myth right now: The pundits have it wrong.
And I can prove it.
This is an important point. You see, all this chatter about froth, exuberance and bubbles now has a big group of investors worrying about losing their money in a fiery, tech-led collapse.
But they actually face a very different risk – the risk of getting left behind when the market that they gave up on – and cashed out of – continues to steam ahead.
We don’t want that to happen to you.
For that reason, I want to show you the five catalysts fanning talk of a tech bubble, and then let you see why the best is still to come for tech-sector investors.
Given the sharpshooter that I am, let me take careful aim at each of these five myths, and gun them down one at a time.
Tech Bubble Myth No. 1: IPOs Are Reaching Insane Heights
Earlier this month, Forbes magazine cited the recent IPO for Twitter Inc. (NYSE: TWTR) as “proof” we’re in a tech bubble.
No doubt, the social-messaging company’s $22 billion market valuation sounds high for a firm that is still losing money. The pundits also see Twitter’s first-day gains of 73% as frothy.
But I believe Twitter is a unique stock that commanded top dollar simply because it has 550 million users around the world. If each one just bought five shares, the Twitter IPO would have been significantly oversubscribed.
Overall, however, tech IPOs have not even come close to entering “bubble” levels. Yes, the average year-to-date gain for a tech IPO is 60%. But that average also includes biotech stocks and is less than twice the overall market’s 31% gain.
That disparity may sound large but doesn’t even approach the vast gulf that you see in a true tech bubble.
During the heady dot-com days of 1999, tech IPOs showed annual gains of more than 260%, a figure that was more than four times the 59% average for non-Internet IPOs.
By definition, growth companies – those with double- and triple-digit earnings growth – trade at higher multiples than “mature” industrial or transportation firms, simply because the young upstarts have so much more earnings potential ahead of them.
Tech Bubble Myth No. 2: Tech Stocks Are Incredibly Expensive
I hear this one a lot these days. In fact, every time I turn on a financial news show there’s at least one pundit saying that tech-stock valuations are out of line and make no sense.
Well, I believe the best way to compare relative value for growth stocks is to look at the “forward P/E” – the valuation of a stock based on a company’s projected earnings in the year to come. Because this figure gives you a sense of the premium you’re paying for the growth to come, I feel it offers a more-realistic assessment of whether a company is over, under or fairly valued.
Viewed in that context, tech stocks aren’t overvalued.
In fact, they’re cheap.
Statistics compiled by Birinyi Associates and The Wall Street Journal show that the tech-focused Nasdaq 100 trades at roughly 18.05 times forward earnings.
That’s actually less than the Dow, which has a forward Price/Earnings (P/E) ratio of 18.55. And when you consider that the tech sector has a much-higher earnings growth potential than its blue-chip counterpart, it’s easy to see that the tech sector isn’t trading at anything close to “excessive” premiums.
You’ll actually find some tech leaders selling at bargainvaluesright now.
Take the case of Apple Inc. (NasdaqGS: AAPL). Even though it has a profit margin of nearly 22% and a return on stockholders’ equity (ROE) of 30%, it still only trades at less than 11 times forward earnings.
Then there’s Microsoft Corp. (NasdaqGS: MSFT), which trades at less than 13 times forward earnings. The software giant is a cash machine. It generated nearly $19 billion in free cash flow (FCF) last year.
Tech Bubble Myth No. 3: 3rd Quarter Tech M&A Activity Soars
In its Nov. 3 issue, Business Insider pointed to a recent surge in tech mergers-and-acquisition deals as proof of an inflating tech bubble.
Business Insider even ran a chart by consultant PriceWaterhouseCoopers (pwc) showing that third-quarter M&A soared 33% from the same period in 2012.
There’s just one problem. The publication failed to mention that third-quarter deal volume benefitted heavily from the fact that there were far fewer deals in the first half of the year.
In fact, that very same pwc study noted “technology M&A activity stumbled along in the first half of 2013 amid a fog of market uncertainty.” It wasn’t until the third quarter deals returned to “historical levels.”
In other words, dealmakers looked at the debt-ceiling deadline, the Obamacare mess and the expected “tapering” of the U.S. Federal Reserve and put any transactions on hold. And when the government-shutdown ended and it became clear that the central bank’s cheap-money spigot would remain on, Corporate America’s wheeler-dealers made up for lost time with a flurry of deals that made the third quarter appear overheated. Instead, these guys were just playing “catch up” and doing the deals they couldn’t carry off in the first six months of the year.
Tech Bubble Myth No. 4: There’s Too Much Venture Capital Chasing Startups
As the founder of the VC firm Draper Fisher Jurvetson, Timothy Draper is a bona fide Silicon Valley legend.
Since its founding in 1985, Draper Fisher has backed more than 400 startups in software, mobile, clean-tech, energy, healthcare, and other “disruptive” (game-changing) categories.
In the same Nov. 3 issue we cited in Myth No. 3, Business Insiderreported that Draper had basically said the recent era of successful venture funding is nearing its peak. Business Insidercited that factoid (from a New Yorker article) as evidence that a tech bubble was already inflating.
So I went back and checked the numbers.
Once again, they told a very different story.
Turns out that venture funding for early and mid-stage firms, mostly in tech and the biosciences, rose sharply in this year’s third quarter.
Thomson Reuters and the trade group National Venture Capital Association found that U.S. venture firms raised $4.1 billion during the third quarter of 2013. That’s an increase of 28% compared to the level of dollar commitments raised during the previous quarter. And it was mostly for early and mid-stage firms, chiefly in tech and biosciences.
As was the case with M&A, the first part of the year really stunk. In fact, if you drill down and look at all the numbers, VC funding is actually down 29% for the first nine months of 2013.
In other words – just as we had with dealmaking – the uncertain backdrop in the first part of year kept the VC cash on the sidelines. It was only after Washington got its act together (relatively speaking) that the venture capitalist money flowed again.
Early in the year, the industry saw “less money going into traditionally capital-intensive sectors such as clean tech and life sciences, especially in first-time deals,” said John Taylor, head of research for NVCA.
Added Taylor: “The majority of deals are being done in the capital-efficient IT sector where rounds’ amounts are lower. We expect these overall trends to continue until exits and subsequent fundraising activities pick up, and dollars start to flow back into more venture funds.”
The bottom line: VC funding is down this year – a lot – which is the polar opposite of a funding “bubble.”
Tech Bubble Myth No. 5: The NASDAQ Is Moving Too Quickly
When you “cherry pick” data, you skew reality. And as we’ve seen here, pundits have been cherry picking the stats that best prove their point.
And a favorite bit of cherry picking right now is to cite the current level of the tech-centric Nasdaq. It recently hit 3,950, meaning that it’s flirting with the psychological milestone of 4,000. And that’s bringing the “bubble chanters” out of the woodwork.
The analysis is usually pretty superficial. You see, the last time the Nasdaq got this high was right before the dot-com bust of 2000.
Therefore, the reasoning goes, tech is once again in a bubble and about to burst.
But this analysis ignores a big reality. Yes, as we showed you at the start, the Nasdaq is outrunning the blue-chip indices – but certainly not by “frothy” or “euphoric” levels that constitute a bubble.
Over the past five years, for instance, the bellwether tech index is up about 185%. That’s a 62% premium to the S&P 500’s 123% gain. But spaced over the five years, you’re talking about average outperformance of only 12% a year.
And that’s all well within the premium performance we’d expect to see for firms with such superior earnings growth – which are the kinds of companies that live in the Nasdaq.
Just look at the small-cap-focused Russell 2000 index, whose five-year surge of 172% is very close to the Nasdaq’s run.
Talk of a “new” tech bubble is based on cherry-picked data, erroneous analyses and a few out-of-context facts … all tweaked to foment fear of a tech-sector collapse.
In other words, there is no bubble – it’s a myth.
And that myth is busted.
Now we can turn back to the mission at hand – ferreting out the high-potential profit opportunities that will help you substantially boost your net worth.
Be sure to join us on our next foray … early next week.
Until then have a great weekend.
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