Further fueling the bubblenoia is Facebook’s purchase of WhatsApp, the proprietary, cross-platform instant messaging subscription service, for a whopping $19 billion. Yet, the jury’s still out on whether Facebook, a company that’s all about personal communication, overpaid to corner the market on the hottest messaging technology. And besides, Facebook had the cash – unlike 90s tech companies that went into debt with little revenue.
The thing to remember about tech companies is that they play by different rules than companies in other sectors. The best among them consistently come up with products that consumers or businesses didn’t want or need before they existed. Thus, these companies create new markets purely from innovation. Think about this the next time you pull out your iPhone to check your email or view the Web on your television screen.
By contrast, consumer staples firms like Procter & Gamble can’t create their own markets. P&G’s P/S ratio is about 3, but for the company to sell more tooth paste, there must be more population.
Because some tech companies play by different rules, they should be evaluated differently. This is also true of some companies that we might not think of as tech stocks now but would have in the 1990s. A prime example is Amazon, which has turned the ’90s promise of Internet sales into a gangbusters reality. Though the company’s P/S is only about 2, its earnings are negligible — but for the right reasons. Amazon focuses on keeping product prices low and on relentless reinvestment, pouring money into thing like distribution centers and Kindle Fire updates. Amazon’s strategy is to first rule the world and then turn on the earnings spigot. The market likes Amazon’s brisk sales and intrepid development, so it forgives the relative lack of earnings.
Of course, just because there’s no tech bubble these days, this doesn’t mean that some tech companies aren’t over-valued. Tesla Motors and Netflix seem pricey, as do Angie’s List and Yelp. SolarCity, which manufactures solar energy gear, is trading at 25 times sales (a P/S of 25). It has sales of only $197 million against a market capitalization of $5.8 billion. One reason for its price is a federal tax breaks, but this could change with the next presidential administration.
The government’s largess toward Tesla, the electric car manufacturer (which also gets various clean-tech tax breaks) also could end, so it may be over-priced. Yet this hardly amounts to irrational exuberance toward the entire sector.
Tech stocks are the largest sector in the S&P 500 Index, at 19 percent. But unlike real portfolios, the S&P 500 doesn’t weight stocks — it just includes them in the index. To the extent that you can choose the right tech stocks (consistently innovative companies with sales that continue to rise) and weight them wisely, you might want more than 19 percent of the companies in your portfolio to be tech firms.
This way, you’ll be positioned to reap earnings from sales of products that don’t yet exist.
Dave Sheaff Gilreath is a founding principal of Sheaff Brock Investment Advisors LLC. He has more than 30 years of experience in the financial services industry, beginning with Bache Halsey Stuart Shields and later Morgan Stanley/Dean Witter. At Sheaff Brock, he shares responsibility for setting investment policy, asset allocation and security selection for the company's managed accounts. He also consults with the clients on portfolio construction. Gilreath received his Certified Financial Planner® (CFP) designation in 1984. He attended Miami University in Oxford, Ohio, where he earned a B.S. degree.
Any opinions expressed are solely those of the author and not of ABC News.