It’s Different This Time for Tech Stock Valuations

Marc Andreessen, a venture capitalist, remains best-known for his work on the creation of Netscape, one of the earliest and best web browsers.  In a recent interview with The Wall Street Journal, he states that those who are concerned about a new stock market bubble in tech stocks simply don’t understand the revolution that is underway and how large an economic impact software firms can have. 

Andreessen’s firm is an investor in Pinterest, which still has no revenues at all, but he asserts that the company is worth $3.8 Billion.  So, of course, there is a self-serving element in his assertions that the naysayers simply don’t understand the new reality of Internet firms.

To those who remember the last tech bubble and its subsequent demise, the revival of arguments as to why things are ‘different this time’ and why traditional measures of fundamental value such as the price-to-earnings ratio don’t matter will bring back memories of companies like Pets.com.  On the other hand, the market as a whole clearly buys into Andreessen’s argument.  Twitter recently went public and currently has a market cap of $35 B with negative earnings per share (EPS).  LinkedIn (LNKD) is worth $24 B and has a price-to-earnings ratio (P/E) of over 900.  Netflix (NFLX) has a P/E of 300.  Pandora (P) is worth $6 B and Yelp is worth $4.7 B and both have negative EPS.  Compared to these, Facebook (FB) looks positively modest with a P/E of only 144.

To put all of these numbers in context, however, it is important to know that Google (GOOG) has a P/E of 30 and Apple (AAPL) has a P/E of 13.7.

There is, of course, a case to be made that today’s internet companies are different.  The idea of selling pet food on the Internet (Pets.com) is, in retrospect, lacking in a compelling value proposition.  Social media provides entertainment to millions of people, displacing competing attractions.  The providers of ‘social media’ don’t pay anything for the content—they simply provide the conduit for sharing.  There is no question that this is a new and vastly-growing opportunity.  The providers of streaming video, music, and other content (AMZN, NFLX, P) are also radically altering the landscape.  Tablets and smart phones bring new meaning to ‘window shopping’ by allowing consumers the immediate gratification of instant access to purchases.  These companies are also integrating media content and hardware into one business.  Amazon sells Kindles and then sells the content that customers consume on the Kindle.  Apple sells tablets, the content for the tablets and also the App Store.  So, yes, this generation of Tech stocks is very different than the last.

The overall issue is not whether the latest tech stocks are great companies.  Many of them clearly are.  The question is whether they are worth their exceedingly high valuations.  Pinterest has more users than LinkedIn or Twitter with an estimated 21% of online adults having used the site in the last year.  The ability to corral this many eyeballs is phenomenal.  The question, however, is the extent to which these visitors are going to provide revenues.  This is the part that remains something of a leap of faith.  Google and Apple dominate their respective business spaces, yet you can acquire a dollar of earnings from these firms far more cheaply than you can from the host of newcomers.

So, once again, it comes down to valuation.  Ultimately, what matters is how much you have to pay for a dollar of future earnings.  For companies without earnings, this requires a substantial leap of faith that current projections are meaningful.  The new tech stock leaders are awesome, but are they awesome enough to justify their prices?  Perhaps Mr. Andreessen is correct, but we must always remember Warren Buffett’s wise adage that you don’t ask a barber if you need a haircut.  Similarly, it is probably meaningless to ask a venture capitalist with his money in tech stocks whether there is a bubble.

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