In one swift day of catastrophic trading, the major stock indices erased all of their 2011 gains and foreshadowed a major turn for the worst in market sentiment. Uncertainty about eurozone instability, the rushed US debt-ceiling deal, and poor jobs indicators overall coalesced into massive investor fear that resulted in the sharpest drop since the subprime crisis peaked in 2008. We believe there is more to come for a few of the tech stocks that have been trading at inflated values throughout the recession.
Apple (NASDAQ:AAPL) is one of the most prominent stocks to examine, having been on an unstoppable climb since the beginning of 2009 from about $90 per share to last week’s breach of $400 a share. With another quarter of spectacular results, analysts have been painting ever rosier outlooks for Apple’s price targets. It’s true that Apple has some of the hottest tech products on the market, especially the iOS smart phones and tablets that consumers are lusting for. However, with such poor jobs and housing data, one must question whether the company can keep up its sales growth through the end of the year.
A key factor here is whether you believe Apple is actually a maker of high-quality consumer goods or a seller of a luxury lifestyle brand. If it’s the latter, Apple may have a better chance of surviving by catering to a well-off niche, although growth from the middle class may slow. If it’s still the former, the mass market demographic may tighten spending and choose cheaper alternatives to Apple, damaging growth more severely. What’s more worrisome is that Apple’s prices will be most severely undercut in emerging market nations where consumer technology spending is still increasing. With either scenario, expect Apple to run into much dimmer growth prospects in the near future, as partly indicated by yesterday’s 3.87% fall.
Netflix (NASDAQ:NFLX) has been a value investor’s dream stock as its value rocketed from the mid-$20s to nearly $300 per share in recent weeks. However, the price swings of NFLX have started becoming more volatile in the past six months as bad news followed good news following bad news. Unfortunately, this latest round of weak economic outlook could be enough to make investors send Netflix towards a significant correction, hinted by the latest 5.5% drop to $246. The DVD rental business has competition from Redbox and a revamped Blockbuster, while online streaming faces the likes of Hulu and Amazon (NASDAQ:AMZN), among others. With the company’s recent move to restructure its DVD rental and online streaming fee system, Netflix essentially instituted a price hike on a highly elastic luxury good. As a result, consumers looking to shrink household bills will cut off Netflix along with extras like cable television and eating out.
That economic reality should awaken plenty of NFLX shareholders to the realization that the company can’t satisfy, let alone exceed, the growth expectations that have the stock trading at over a 60x PE ratio. Even under a best case scenario, Netflix stock’s current valuation has been shaky for a while, and the current market environment will only worsen the stock’s prospects.
Salesforce.com (NYSE:CRM) has been a longtime player in the cloud-computing industry, which is just starting to attract plenty of buzz. The company provides a number of different online platforms labeled as customer and collaboration relationship management services (aptly named CRM) that work to help customers record, analyze and use their business’s data.
Salesforce seems to be doing well financially, having beaten out analyst estimates in recent quarters, and has issued FY2012 guidance above expectations. Apply generous amount of skepticism here though; the trendiness of new buzzwords, such as “cloud computing,” means that a company can get overvalued no matter what it’s doing. This is clearly visible in the stock’s current price of 221 times earnings and a ridiculous 400x forward price to earnings ratio. Salesforce services are meant to bring long-term cost reductions, but fewer companies will be willing to invest in any new technology as the economic future becomes darker and cloudier. As times get tougher, Salesforce.com will have to revise its guidance downwards, along with its currently unsustainable market valuation.
Google (NASDAQ:GOOG) has always traded at a fairly high valuation, so its current stock price of $577.52 seems conservative when compared to a pre-recession high of over $700 a share. As we saw in 2008 though, Google as a brand and as a stock is not immune to the effects of a market downturn and GOOG tumbled to a low under $300 per share just a year after that high note. If yesterday’s market panic is to be taken as a bellwether for a worrisome double-dip recession, Google could end up in just as poor of a situation as three years ago. Even though this time YouTube is becoming more profitable and Google+ is entering the social media fray, Google still depends on simple text ads along with some banner ads for the majority of its revenue.
During recessions, corporate advertising budgets dry up along with consumer spending and marketers are forced to be much craftier (and more frugal) with how ad money is used. As a result, Google will either have to lower its margins or advertisers will simply buy fewer ads. GOOG has only suffered a moderate 3.93% decline so far, but the stock is still trading at a bold 21x PE. If the US economy worsens and another recession shapes up, prepare to see Google’s earnings take a big hit along with its share price.
OpenTable (NASDAQ:OPEN) is an interesting case because it’s from the Web 2.0 IPO generation so it’s still easy to justify its price of $61.28 per share, equaling a sky-high P/E ratio of 77x. With only a brief public market history, analysts will have to forecast its performance potential from the broader fundamentals of its business. Fortunately, OpenTable operates a down-to-earth service, providing reservation-related infrastructure for restaurants and patrons, such as online booking and table management. The cost and time savings from OpenTable are great for businesses and consumers from a long term perspective, similar to Salesforce’s platform.
For now though, investors know a recession pinching the middle class is bad news for OpenTable’s business model and will punish the stock accordingly. As consumers try to save money in the coming months, eating out at restaurants will be one of the first expenses to evaporate. This causes the OpenTable service to be more expensive per diner and prevents many potential restaurant clients from implementing the infrastructure until after the economy improves. This downtrend has already started to take shape with the shortfall in OPEN 2Q11 revenue, and it will only worsen if the recession deepens.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.