With great risk can come great reward. But when it comes to tech stocks, investors should be cautious about reaching for the stars too often.
After all, you can only survive so many falls from the sky.
Some worry that a new bubble is brewing in technology. While San Francisco Chronicle business reporter Thomas Lee aptly points out that it’s nearly impossible to predict extreme events like bubbles and their subsequent bursts, many in the space fear that’s where we’re headed nonetheless.
There is one merciful difference, though, between this so-called bubble and the one from the dot-com era. Consider this thought from InvestorPlace Executive Editor Jeff Reeves, who regularly comments on the market via Fox Business, MarketWatch and USA Today:
“Private equity and hedge funds are looking for alpha, and there are like 15-20 ‘disruptors’ where you can find that right now. I’m sure you can list them all: Uber, SnapChat, DropBox and so on. That means a feeding frenzy for this group of 15 to 20 startups and also a race to get into the next 15 to 20. How can you beat index funds unless you chase the next Uber?”
The bottom will at some point fall out, he says … but the “good news” is that it will hit Silicon Valley insiders and venture capitalists this time around, as opposed to Main Street investors like you and me, because much of the froth is in the privately held space.
But not all of it.
Tech Stocks: When Hype Meets the Wall
Yes, tech IPOs have dwindled from 632 in the 1999-2000 span to 49 last year, and information technology is one of just two S&P 500 sectors with forward 12-month price-to-earnings ratios that are below their 10-year averages. But there is froth in the space, as some bubbly tech companies have gone public.
Just take a look at these examples of tech startups that have gone public, aren’t profitable and haven’t made for very good public investments:
- Twitter (TWTR) was seen as a hot social media startup that went public in 2013 and ran up early on hype that it was a Facebook (FB) disruptor. However, the company has yet to make a profit on a GAAP basis, and following a roughly four-month decline of 45%, shares are now off some 20% from their first day of trading.
- Hortonworks (HDP) — seen as a hot Hadoop company and legacy tech vendor disruptor — went public in 2014. And while it surged after its most recent “earnings” report (HDP still hasn’t posted a profit) it’s still basically flat since coming public.
- This year’s disappointment is this year’s example is Box (BOX), a hot name in cloud computing and storage. It enjoyed a brief respite in June after reporting earnings, but ultimately, Box doesn’t have any earnings to report, and Wall Street has quickly fallen out of love with this company, sending shares down roughly 40% since their first day of trading.
Investors in these companies were betting on disruption translating into rampant growth and eventually profits down the line. The hope? Finding the next Google (GOOG, GOOGL) or Facebook on the ground floor.
But for every Google, there are hundreds of flops, and the odds are getting even worse. The tech world is moving faster than ever before, and it’s cheaper than ever before to launch a startup — meaning there are a lot more darts being thrown at the dartboard, while bull’s-eyes remain slim.
And let’s not forget that, hey, tech is complicated. It’s easy to be mesmerized by buzzwords and fads, but a successful investment requires an actual understanding of a company’s technology, as well as its business model. That requires a good deal of digging beyond headlines and hype.
There’s a reason renowned investor Warren Buffett generally avoids tech — a sentiment expressed while warning folks about the sector back in 1999.
None of this is to say you should avoid tech stocks completely, or even avoid tech IPOs. But it does mean you should do so with caution, and certainly with both eyes open.
For one, remember that not every good product makes for a good company. Twitter is an insanely popular and useful service, but again, for all its growth, TWTR has yet to figure out how to turn hundreds of millions of users into black ink.
And until those profits come, investors will demand growth from somewhere, and that somewhere is usually the top line. So if your hot tech investment starts seeing issues with slowing users and/or revenues at a time when profits are years down the road … again, that’s a big, red flag.
Sidestep the hype. Do the legwork. And always be prepared for the bottom to fall out.
Alyssa Oursler is based in San Francisco and writes about technology, investing, gender and entrepreneurship. Her work has appeared on Business Insider, MSN Money and more. You can follow her on Twitter here or check out her personal site here. As of this writing, she did not hold a position in any of the aforementioned securities.