An investment bubble has formed in the prices of web 2.0 companies. Many of these firms lack consistent profit or free cash flows to equity. In short, they have yet to prove that they have any fundamental, intrinsic value for their equity owners. Certainly, companies like Zynga (ZNGA), Yelp (YELP), LinkedIn (LNKD) and Groupon (GRPN) might be amazing, have high traffic, high user counts, or other impressive metrics. However, in the absence of positive earnings or positive cash outflows, these metrics just show how fast these companies are spinning their wheels. They are not a meaningful basis for valuing a company.
Will investors ever learn? Time and time again, they keep getting drawn into investment manias. These bubbles are based on enthusiasm and greed for flipping assets with ever higher prices, independent of underlying value. If investors would only require reasonable fundamentals, they would avoid buying companies based on hopeful scenarios
In the end, investment returns are ultimately dictated by earnings and cash outflows. Independent research allows investors to go beyond popular fads to shop lesser-known alternatives. As simple as it sounds, you are better off shopping around than using today's fads as a filter that selects for familiar products or popular stocks.
Notice the disparity between web 2.0 stocks and the following technology stocks with more reasonable valuations:
Ticker | Company | P/E | P/S | P/FCF |
(ACN) | Accenture plc | 17.2 | 1.5 | 16.6 |
(BMC) | BMC Software Inc. | 14.7 | 2.9 | 8.5 |
(BYI) | Bally Technologies, Inc. | 23.7 | 2.5 | 25.6 |
(CSGS) | CSG International, Inc. | 12.5 | 0.7 | 18.3 |
(CVG) | Convergys Corporation | 4.6 | 0.6 | 13.3 |
(DNB) | Dun & Bradstreet Corp. | 16.1 | 2.3 | 21.5 |
(DST) | DST Systems Inc. | 13.8 | 1.0 | 7.9 |
(IBM) | International Business Machines | 15.4 | 2.2 | 19.9 |
(JKHY) | Jack Henry & Associates Inc. | 20.4 | 3.0 | 19.8 |
(ZNGA) | Zynga, Inc. | N/A | 8.8 | 67.9 |
(YELP) | Yelp Inc. Class A Common Stock | N/A | 16.2 | N/A |
(LNKD) | LinkedIn Corporation | 755.6 | 17.8 | 250.7 |
(GRPN) | Groupon, Inc. | N/A | 6.6 | N/A |
These old-school tech stocks are cheaper than the hotter web 2.0 stocks based on past earnings, free cash flows and lower price multiples. What's more, these older tech stocks are quality firms with positive growth forecasts:
Ticker | Industry | 10-Year Average ROE | Altman Z-score | EPS growth next 5 years |
ACN | Information Technology Services | 6.6% | 5.86 | 10.6% |
BMC | Application Software | 13.3% | 3.67 | 9.4% |
BYI | Application Software | 15.7% | 4.24 | 23.1% |
CSGS | Business Software & Services | 21.7% | 3.07 | 7.6% |
CVG | Business Software & Services | 6.2% | 3.77 | 8.2% |
DNB | Information & Delivery Services | 36.4% | 4.13 | 9.6% |
DST | Information & Delivery Services | 42.6% | 3.15 | 8.0% |
IBM | Diversified Computer Systems | 38.9% | 4.56 | 10.6% |
JKHY | Business Software & Services | 16.5% | 5.46 | 11.1% |
These alternative stocks are all categorized as "safe" according to the Altman Z-score,* indicating that they are not considered bankruptcy risks. Moreover, the average 10-year equity returns demonstrate these firms have grown shareholder wealth at respectable annual rates. It is clear from these two metrics that each of these ten alternative stocks is a "high" quality stock capable of weathering bad times and delivering positive long-term results.
Consider a diversified mix of these tech stocks as a more attractive alternative so the social media bubble. They may not be shinny and new, but they have survived the first tech bubble and are reasonably priced.
*Please read the article disclaimer.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
