Don’t Fear the Dot-Com Bubble, Fear a Value Crash

by Tom Taulli | April 29, 2014 10:46 am

Last week, the social and cloud tech stocks continued their plunge.

dot-com bubble, tech stocksSo is this really the sequel to the dot-com bubble? As with any market forecast, it’s impossible to say for sure. But upon close inspection, the tech surge the preceded the recent implosion isn’t very similar to the dot-com boom.

During the dot-com boom, traders were manic for internet stocks. People ditched their jobs to become day-traders, making millions. CNBC became a must-see channel and stock analysts turned into celebrities (that’s when Henry Blodget got his start). IPOs became guaranteed pathways to riches, as any company with a “.com” in its name soared.

But after a couple years, the dot-com bubble popped, and the results were horrendous. Many companies went bust because the underlying business models were flawed. Hey, when the capital quickly dried up, there was no way to pay the bills.

In comparison, the dot-com bubble does look like something much different from the current tech stocks move. This time around, the companies that have gone public are fairly solid (consider that many have waited much longer than their dot-com counterparts). It’s a good bet that Workday (NYSE:WDAY[1]), ServiceNow (NYSE:NOW[2]), LinkedIn (NYSE:LNKD[3]) and Facebook (NASDAQ:FB[4]) will be around for a long time. They are also enjoying the growth from megatrends like the cloud, mobile and Big Data.

Despite the differences from the dot-com bubble, these tech stocks may still crash. In fact, the best historical parallel is actually a long-forgotten bust in tech stocks — one that got its start back on April 22, 1970. In investment annals, this became known as “back to earth” (it happened on the first “Earth Day”) and marks the point when the founder and CEO of EDS, H. Ross Perot, lost about $450 million because of a grueling selloff.

Before this point, the markets were in a massive bull mode, led by “go-go” growth stocks. There was an explosion of IPOs of cool tech companies like Control Data, Mohawk Data, Sperry Rand, and NCR (NYSE:NCR). The late 1960s also marked the emergence of powerful mutual funds, which poured money into the go-go stocks.

But from April 20th to May 26th, the go-go stocks crashed. Many of them suffered stunning 80%+ declines, including EDS. However, unlike the dot-com bubble, many of the go-go tech stocks were solid operators. In fact, when EDS nosedived, the company still posted a Q1 jump in net income of 70%.

No doubt, the go-go stock crash should definitely be worrisome for today’s tech stocks because it suggested that the fundamentals weren’t enough to hold up tech stocks. In other words, it may not matter if today’s hot tech stocks are strong companies or not. It may not matter if the future looks promising and that there are exciting innovations to come. It may not even matter if the growth continues.

Already, it seems like Wall Street is taking this view. Just last week, the shares of Facebook and Pandora (NYSE:P[5]) fell despite posting strong quarterly reports.

Oh, and even with the recent drop in tech stocks, the valuations are still at lofty levels. Here’s a look:

Company Ticker Price-to-Sales Price-to-Earnings
Facebook FB[4] 17 74
Twitter TWTR[6] 38 N/A
Yelp YELP[7] 19 N/A
LinkedIn LNKD[3] 13 709
ServiceNow NOW[2] 16 N/A
Workday WDAY[1] 28 N/A

By comparison, Google (NASDAQ:GOOG[8]) has a price-to-sales ratio of only 5 and a PE multiple of 27. True, the company is at a different stage of its life, and its growth has been trailing off. But even if you doubled the price-to-sales multiple for GOOG, the dot-com and cloud operators still look highly overvalued.

This doesn’t necessarily mean a crash is inevitable. There might even be another rally. But history shows that high valuations cannot persist forever, and the end-game can be brutally swift. Given the recent erosion, a crash looks like a reasonable possibility.

Tom Taulli runs the InvestorPlace blog IPO Playbook[9]. He is also the author of High-Profit IPO Strategies[10]All About Commodities[11] and All About Short Selling[12]. Follow him on Twitter at @ttaulli[13]. As of this writing, he did not hold a position in any of the aforementioned securities.

  1. WDAY:
  2. NOW:
  3. LNKD:
  4. FB:
  5. P:
  6. TWTR:
  7. YELP:
  8. GOOG:
  9. IPO Playbook:
  10. High-Profit IPO Strategies:
  11. All About Commodities:
  12. All About Short Selling:
  13. @ttaulli:

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