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The developments on the NASDAQ on Friday; where the high end players on the index came crashing down, are more likely the ignition of the catalysts that have been building over the past six to 12 weeks.
Valuations have become astronomical in some of the social media names, none more so than Facebook. Facebook’s current price to earnings (P/E) ratio is 145 times. Its forward P/E is a more respectable 50 times earnings. Considering Facebook’s cheque book has had an extreme workout as it snapped up WhatsApp and Oculus for a combined price tag of US$21.5 billion, cash flow will be impacted in its earnings release this month. These purchases will impact forward P/Es - revisions are coming.
The same conclusion can be seen in Telsa, Netfix and Twitter, and even Amazon is expensive on fundamental valuations. There will be a price to be paid for those that are pushing the valuation bubble.
The Fed has been pumping funds into the system now for six years and the demand for information, connectivity and flash-media stocks have been trades easy to write. However there has to be a point where the hot growth trade runs out and short trade ruler begins to review the metrics – fundamentals often lag the market but will always catch up sooner or later.
So are we seeing the fundamentals catching up to the tech space? I think the tech space is one of the more exciting sectors in the world, and I think it will be one of the most influential growth spaces of the next 15 years (along with agribusiness and energy).
However even rapid-growth plays need to support share prices with earnings, and I think we are seeing the development of a correction in this space as forward P/E routinely average over 35 times, and that will catch up as the Fed continues to slow QE and earnings are found wanting to price.
Australian Tech mix
The question therefore becomes: are Australian growth tech plays facing the same issue? I think they are; I have been a great supporter of the Australian dot.com, info tech and communications spaces, and still believe they are well run companies with very solid growth stories.
However from a share price perspective, with valuations at over 30 times earnings and some possible slack in the market, these stocks are walking a thin line.
Plays that have been star performers over the past year that look more than fairly valued included REA group, Seek, Carsales.com.au, Domino pizza and TPG Telecom. These are great companies with great prospect but are way overvalued one miss step and the short play is on.
Then there are those that are overvalued, overbought, overestimated and under-delivering, none more so than Xero. I understand the excitement behind this stock; cloud technology is certainly a clear technology of the future. However on Friday it reported negative earnings that doubled in the last 12 months, with a revenue stream totalling NZD$94 million. With a market cap of AUD$4.4 billion, that means XRO is trading at 69 million times revenue. If ever there was a price multiple trap, XRO is it.