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Are We in a Tech Bubble Again?

Wednesday, 6 Jul 2011 | 10:03 AM ET

There is a familiar sense of déjà vu. In some ways, it's the year 2000 once again in the IPO world.

Bernhard Lang | Getty Images

Zynga, maker of social games such as "FarmVille" and "CityVille," becomes the latest company to feed the social-media frenzy with its IPO plans to raise US $1 billion.

If successful, Zynga will be the largest IPO for a U.S. Internet company since Google in 2004. This company would be larger in market cap then Electronic Arts or Activision. The offering pegs the company at a $20 billion valuation!

Shares of Pandora, the loss-making online music service soared by more than 60 percent when it began trading, while Linkedin shares jumped nearly 110 percent on its first day of trading.

Microsoft said it plans to buy Skype, an internet video service, for a frothy looking $8.5 billion. This is 10 times the amount of its sales last year and 400 times its operating income.

This is no shortage of internet start-ups and social media companies to choose from. Twitter and Facebook are not listed but are expected to price soon. Already, secondary-market trades value them at some $76 billion (Facebook) and $7.7 billion (Twitter).

The game is also not limited to America. China’s start-up tech companies are also jumping onto the IPO bandwagon. Renren, hailed as China’s Facebook, and Youku, China’s YouTube, have all burst onto the online space with very high valuations.

How quickly we forget. And perhaps amidst our euphoria we should ask:

Can we trust current valuations?

Is it different this time?

Has irrational exuberance returned to the technology world?

If a bubble is defined as prices not currently justifiable by current earnings, then yes we are currently in a bubble. Companies that come out with PE ratios of 100 or no PE ratio at all because they lack real earnings are speculative in my book.

It’s hard for me to justify investing in a company that has little profit. Yes, momentum might push the stock higher, but if you are focused on fundamentals, the earnings need to be believable and sustained.

The slew of tech IPO listings in the past six months have generally been companies with revenue growth but very little profitability. Many of these companies have been focused on particularly hot sectors such as Chinese telecommunications and social networking.

These companies are risk-filled propositions with the possibility of huge gains. But at the same time, there is an even greater possibility of titanic losses. A few will win; most will not.

This is not to say that any of these companies might not be the next Google. They might be. The choice investors have to make is how much comfort is derived from purely investing in future projected profits and revenue rather than current earnings.

When Amazon first came to market, it was considered overvalued, but the online company managed to justify its valuation as it continued to grow its revenue and business. There are success stories.

So while it is true that there will be some winners in the latest technology boom, picking them is going to be harder than people think. Investing in stocks that have high valuations with hopes and promises of future spectacular earnings is a risky proposition.

The upside can mean spectacular returns, but the downside can be devastating. In an environment in which the economy remains weak and structural problems continue to plague the global economy, it's important to recognize that investing in highly leveraged and/or new IPO technology companies carries significant risk.

As difficult as it might be, try to recall year 2000 and the cascade of stock disasters. We should not forget the lessons learned during those difficult times.

_______________________________

Michael Yoshikami, Ph.D., CFP®, is CEO, Founder and Chairman of YCMNET's Investment Committee at YCMNET Advisors. Founded in 1986, YCMNET is a San Francisco Bay Area-based independent money management firm that provides fee-based wealth management services to institutional investors and individual investors. The firm works with clients around the world. Michael was named by Barron's as one of the Top 100 Independent Financial Advisors for 2009 and 2010. He oversees all investment and research activities of the firm and is actively engaged on a daily basis in the firm's securities analysis activities and determines the macro tactical asset allocation weightings for client portfolios. He works with YCMNET's investment team in integrating behavioral investing strategies with the firm's core fundamental perspective. Michael holds a Ph.D. in education, other advanced degrees, and holds the Certified Financial Planner® (CFP) designation.

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