Asset bubbles are the main consequences of extremely loose monetary policy. Central banks are printing as much money as they can to drive inflation, but they cannot control where financial institutions and the wealthy who are the first to access this money decide to allocate it. As a result, inflation is never even across the board and the cheap credit leads to speculative bubbles. With record amounts of easing since 2008 financial crisis, there is not just one bubble like in the past (such as housing in 2003-2007 or tech stocks in the late 90's), but also several bubbles growing off each other at the same time. One of the most notable one of these is a second tech bubble revolving around social media.
Just thirteen years after the 2000 dot com bust, we are currently experiencing another internet bubble. Some other technology based companies such as Tesla Motors and 3D printing companies also are trading at high valuations, but the main focus on this bubble is social media and cloud based Internet services. The enthusiasm of the Twitter's (NYSE:TWTR) IPO only confirms this. As seen in the chart below, internet information providing companies are trading at unsustainable premiums. Outside of AOL, these companies are trading at P/E ratio well above fifty and price/sales ratios over ten.
Valuations of Overvalued Tech Names
(November 13, 2013)
*YELP forward P/E 339.22
*CRM forward P/E 108.23
Even adjusted for high growth rates, these companies are still massively overvalued with an average PEG ratio over 4 for all profitable companies. Twitter, Yelp, and Groupon do not make money at all and private companies looking to IPO such as Snapchat and Pinterest don't even bring any revenues. Yet these companies have valuations over $3 billion in market cap. Even with rapid growth, there is little to no chance these companies can grow into their valuations.
Bulls argue that these high valuations are valid due to the amount of users these sites have. Even if their product can be easily replicated by one month's worth of coding from a computer science grad (such as Snapchat), the fact they were the first to over ten million users supersedes a commoditized product. Also, these companies have not managed to monetize the mobile market to large enough of a degree to generate high profit margins, while brick and mortar industries with more fixed costs have all time high profit margins.
Number of users or unpaid subscribers is a similar non-financial valuation metric comparable to the use of clicks and pageviews to value Internet companies such as Pets.com during the tech bubble. Those who disagree are labeled as not getting it. As someone within the target demographic of social media sites, I do not click on any of their ads and as a business owner have avoided advertising through them due to lack of ROI versus online alternatives such as Google, SEO, and e-mail marketing. Users do not mean anything unless there is a high click rate (>1%) or a subscription fee attached.
The trade here is to be patient and wait for technical momentum breakdown and then aggressively short these stocks on the way down. This can be done by the social media ETF (NASDAQ:SOCL) or by finding the least fundamentally sound Internet information/social media companies individually and shorting them.
The weakest and most overvalued companies in this sector are Twitter and Opentable (NASDAQ:OPEN). Twitter drains money and trades at an astronomical valuation. On top of this, sponsored Tweets have a low return on investment , even compared to other social websites such as Facebook. Opentable is also excellent short due to its overvaluation and also due to the rise of competition. Fees are steep for Open Table ($250 per month + $2.50 per reservation), and competitors are cutting them out on pricing severely. Opentable will have to likely reduce prices or lose market share which are both harmful to its stock price.
If Snapchat goes public, they will easily become the best short in the tech sector. Snapchat is easily replicable and has a demographic that little disposable income (and lacks the patience to wait through ads). As a result if Snapchat monetizes aggressively, then they would lose their whole audience to a knock off competitor who will provide Snapchat's service for free. Since the instant deleting of photos and videos is not patent protected, their product can also be easily commoditized.
Overall, I expect all of these companies stock prices to crash, With sky high valuations, lack of intellectual property to create economic moats, difficulty monetizing what customers consider free services, and an overall weak macroeconomic environment are all massive headwinds for these companies. The Nomadic Macro letter will update subscribers when we decide to initiate short positions on any of the listed companies in this column.