Most people agree that US equities are expensive right now, with even bulls conceding that they are on the high side of fair, and the tech sector is more expensive yet. Whether we’ve reached a tech bubble is partially a matter of definition (some people argue that you can’t have a true bubble without private debt fueling asset prices), but research from Mark Berry at FactSet shows that it’s really just part of the tech sector that is getting out of hand.
Tech bubble: P/S deviation more than triple other sectors
“Companies like King Digital Entertainment PLC (NYSE:KING), WhatsApp, LinkedIn Corp (NYSE:LNKD), and even Twitter Inc (NYSE:TWTR) have achieved valuations that, under any typical fundamental-based analysis, defy all logic,” Berry writes. “Twitter, for example, has a Price/Sales ratio currently over 30x, while Facebook Inc (NASDAQ:FB) carries 15.9x. By comparison, Apple Inc., (NASDAQ:AAPL)’s P/S is 3.3x. LinkedIn’s P/E ratio is 680x; Google’s is 31x.”
The median price/sales of tech companies with revenues above $500 million is 2.4x, which is high but not necessarily problematic. But the standard deviation is huge: 5.1 compared to 1.5 for consumer services, 1.4 for transportation, and 1.5 for communications. In other words, it’s actually a handful of stocks that are drawing comparisons to the dotcom bubble for the whole sector.
NASDAQ Composite’s reasonable PE reflects tech megacaps
It’s true that the NASDAQ Composite (INDEXNASDAQ:.IXIC) is pulling away from the S&P 500 (INDEXSP:.INX), and the NASDAQ P/E pulled ahead of the S&P 500 sometime in 2013 and has continued to rise against it. But neither of these differences are as glaring as they were fifteen years ago. If the comparison of PE among the different indexes was all you had to go on, you wouldn’t bat an eye.
But these indices include Apple Inc. (NASDAQ:AAPL), Google Inc (NASDAQ:GOOG) and other tech giants that have reasonable valuations and enough market cap to pull the entire average down. The standard deviation that Barry identified, three or four times larger than other sectors, tells us that aggregating data for the entire sector washes out important details. David Einhorn at Greenlight Capital Management has been warning about a tech bubble for a while now, but he is also long on Apple last we heard, so clearly that’s not what he’s talking about.
Really, we need a different moniker for the kinds of companies that has value investors worried, the ones with obviously problematic business models (like King Digital Entertainment PLC’s (NYSE:KING) near total reliance on a single, tired product) or the lack of a realistic plan to become profitable (like Coupons.com Inc (NYSE:COUP) which has been losing money for years).