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I am typically a very optimistic investor and strongly prefer long positions to short positions. However, I believe that the current tech bubble has to burst as a result of the world's recent macroeconomic issues. In this article, I describe what types of companies I group into this bubble and I name a few specific examples including Salesforce.com (CRM), LinkedIn (LNKD), and Pandora (P).

Today's tech bubble stocks are pretty easy to spot. They are shares of companies in the technology sector competing in "hot" areas including social networking, cloud computing, and value chain modernization. From a fundamental standpoint, every tech bubble stock is highly overvalued since they trade at P/E ratios starting in triple digits. Although they have strong growth potential, it still does not justify why their stock should be so valuable now. I believe that investors are going to put their money in safer investments, which provide more cash flow and have less risk. This will cause these bubble stocks to drop in value to what they are truly worth, because demand for equity in each bubble stock's respective space will strongly decrease.

Bubbles about to burst

  1. Salesforce.com sells subscription based software and has played a major part in the cloud computing revolution. It has changed the way that several companies do business and they have a value-added business model. They even feature a social networking tool called Chatter. Salesforce may eventually fall victim to larger players entering the market, including Apple (AAPL), IBM (IBM), Google (GOOG), and Microsoft (MSFT). Also, they have an extremely high P/E ratio at 204 and they have already missed quarterly earnings estimates. Salesforce is expected to have an EPS of $1.87 in FY 2013, which would give them a forward P/E ratio of 66.8 if their price stagnates. Their stock has retained its artificially high value because almost 96% of its shares are held by institutional holders. Once the public begins to hold more shares and the powers of the market take over, CRM will drop quickly.
  2. LinkedIn has virtually no net income and is expected to have an EPS of only $0.33 in FY 2012. Their revenue for 2011 is expected to be about $500 million, yet their market cap is over $7 billion, or 14 times revenue. With analysts now valuing Facebook at 10 times revenue which is still outrageously high, investors in LinkedIn are more likely to flock towards Facebook shares since Facebook is a better social networking site, with more revenue potential. In addition Facebook already generates earnings so they are more likely to stay in business over the coming years.
  3. Pandora (P) is very similar to LinkedIn in that they do not have positive earnings and are not expected to have a bottom line for a long time. Pandora also has a very easy to replicate business model and I believe that bigger players like Google and Yahoo! (YHOO) will move into the internet radio space and push Pandora out. Pandora is currently one of my favorite websites and I believe they have an excellent business model, but I do not believe that they can maintain a $2 billion market cap. Their revenue is projected to increase to $250 million for the FY ending 1/31/2012, but they are still expected to lose money and using earnings for FY 2013 is too far away to estimate for a small corporation like Pandora.

Just because I believe that all of these stocks are very overvalued, they are still good companies who have given us innovative ideas that will change our lives. However, investors have spent way more cash than these companies' pro-rata income statements warrant and now they are going to have to sell and make safer investments in an unstable economy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: 3 Tech Stocks to Stay Away From