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Investing in tech companies can be a roller-coaster ride. But just as these stocks can soar through the roof, certain overhyped stocks are sure to come crashing down. Don’t get burned by these three overpriced tech stocks.
Billionaire David Einhorn warned us earlier this year that we’re in the second tech bubble in under 15 years.
He’s even told investors that he’s short athenahealth (NASDAQ: ATHN), which is now trading 33% below its 52-week high. The stock still trades at a sky-high P/E (price-to-earnings) ratio of 1,900.
Before Einhorn, fellow billionaire and hedge fund manager Seth Klarman told us of the bubble-like environment the market was experiencing:
“A sceptic would have to be blind not to see bubbles inflating in junk bond issuance, credit quality, and yields, not to mention the nosebleed stock market valuations of fashionable companies like Netflix and Tesla Motors.”
The NASDAQ (INDEXNASDAQ:IXIC) traded below 4,000 shortly after these warnings. However, since this low, it’s up 14%. Investors’ short memories are creating another selling opportunity.
Prem Watsa, known as the Warren Buffett of Canada, runs Fairfax Financial. He’s also gotten in on the bubble talk. In a shareholder letter from earlier this year, Fairfax noted that the current speculation in tech stocks will end just like that of 2000: very badly.
He lists a number of major tech companies trading at extraordinary valuations. These included some fan favorites, such as Twitter, Facebook and LinkedIn, but also makes reference to other interesting ideas. These include NetSuite, Yelp and ServiceNow.
In Einhorn’s warnings from earlier this year, he gave us some guidance, alluding to the fact that any stock trading at a P/S ratio (price-to-sales) above 10 is a good place to start looking for “bubble” stocks.
If you screen for high-flying tech stocks that trade above 10 times sales and have negative earnings, two of Watsa’s names show up, NetSuite and ServiceNow.
One stock that showed up as trading at a ridiculous P/S of 30 is Workday (NYSE: WDAY). What’s more is that the company isn’t expected to generate any income this year or next year. We profiled this grossly overvalued company as one of Andrew Redleaf’s “never never stocks.”
The bubble in tech stocks still appears to be alive and well in certain circles. In addition to the likes athenahealth and Workday, there are a number of tech stocks investors should still avoid:
Here are three tech stocks still in a bubble:
No. 1: ServiceNow (NYSE: NOW)
ServiceNow trades at a P/S ratio of 16 and forward P/E ratio (price-to-earnings based on next year’s earnings estimates) of 300. ServiceNow is a cloud-based company that helps with automating business processes. The company serves the IT service management industry. However, its stock price appears to trading at a valuation that’s well above the company’s growth potential.
The bullish ServiceNow investors point to ServiceNow’s huge market opportunity. The tech stock has a hefty $8.6 billion market cap, but its addressable market might be less than 10% of that. Gartner believes that the IT service management industry is worth just $2 billion. But that’s the entire global industry; ServiceNow likely caters to less than half that total.
What’s more is that the company has had little to no success in “upselling” customers to additional, more expensive, services. With a smaller-than-expected market opportunity, and the inability to penetrate its customer base deeper, ServiceNow is set up to grossly disappoint investors.
No. 2: Zillow (NASDAQ: Z)
Since its IPO in 2011, Zillow shares have soared 320%. The stock trades at a P/S ratio of 23 and a forward P/E of 150. Other high-profile IPOs of 2011 don’t trade anywhere near Zillow’s excessive valuation.
These include Groupon (NASDAQ: GRPN) trading at 1.5x sales and Zynga (NASDAQ: ZNGA) at 3.9x. Arguably the highest-profile IPO of 2011, LinkedIn, only trades at a P/S ratio of 15x.
Zillow is the online real estate company, helping facilitate the buying, selling and renting of various properties. The big news of late is that it’s buying up top competitor Trulia. Shares of Zillow initially soared to over $160 a share on the news, but have since fallen 10%.
Dubbed “Godzulia” by the media, a Zillow-Trulia internet real estate giant will have some 50 million monthly visitors. The companies are banking on the fact that its platform will eventually start attracting big ad dollars. However, will the housing recovery cool off before Zillow can capitalize on its robust traffic? That’s a big risk that investors face.
But from an investment standpoint, does it make sense to buy a share of Zillow for $145 when your cut of the revenues is only $6.56?. That’s what you’re doing when you buy into Zillow at a P/S ratio of 23.
No. 3: NetSuite (NYSE: N)
NetSuite is down 11% over the last year, but its stock still trades at an unreasonably high valuation. Shares trade at a P/S ratio of 12 and a forward P/E ratio of 190. The software company bills itself as a software-as-a-service (SaaS) company that focuses on business management software.
Rather than having a niche, NetSuite tries to cater to a range of customers, with software services in the accounting, enterprise resource planning, customer relationship management and other areas. This makes NetSuite a minor player in the market, ultimately making it difficult to compete with larger, cash-rich players, such as Oracle.
It’s also well behind other players in the SaaS market when it comes to profitability. And it doesn’thelp that the majority of NetSuite’s products are priced higher than more established competitors. That’s especially a problem when you consider that NetSuite’s products aren’tsuperior to others on the market. Being a minor player in a number of markets, while offering subpar products at expensive prices, is a business model nightmare.
Famed investor Peter Lynch always said to buy what you know. I’m a strong believer in this practice. Billionaire Warren Buffett doesn’town tech stocks because he doesn’t know them.
It just seems like a no-brainer to avoid tech stocks with obscure business models and that are trading at absurd valuations. When this tech bubble bursts, it’s going to be very painful for investors left holding the bag.
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Four months from now Apple will be releasing the most technologically advanced phone on the planet. And cautious estimates have them selling 200 million of them. While we love Apple we’re recommending a much less known company today…a company no one is talking about. A company that provides the technology, without which, smartphones couldn’t exist. It’s the company reaping massive profits each time a new Apple (or Samsung) smartphone is activated. In fact, as mobile data usage explodes in the year ahead, its stock is set to soar! Shares are already on the move. So, before this stock moves any higher, read our latest report for all the details: Click here for the full story.