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Larry Cheng is a co-founder and Managing Partner of Volition Capital - a technology growth equity firm investing in high growth, bootstrapped technology companies. He focuses on investment opportunities in Internet applications, information services and software. He currently serves on the... More
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Thinking About Thinking
  • The Great Divide In Technology Stocks 0 comments
    Jan 13, 2011 4:34 PM | about stocks: HPQ, INTC, DELL, MSFT, IBM, ORCL, CSCO, EBAY, NFLX, AKAM, FFIV, AMZN, RAX, VMW, CRM
    There is a great divide taking place in the land of technology stocks.  The “New Guard” of technology companies have a cloud computing, recurring or transactional revenue story with promotional leaders and great spin.  The “Old Guard” of technology companies have big brands and huge presence among customers, but are viewed by some as stodgy and tired.  Here’s how the public markets are valuing these two sets of companies from a P/E ratio perspective:
    The New Guard
    • – 259 
    • VMware – 136
    • Rackspace – 107 
    • RedHat – 91
    • F5 Networks – 77
    • – 74
    • Netflix – 72
    • Akamai – 60
    Median P/E ratio of "New Guard" Companies: 84
    The Old Guard
    • Oracle – 23
    • Cisco – 15
    • eBay – 14
    • IBM – 13
    • Dell – 13
    • Microsoft – 12
    • Intel – 11
    • Hewlett-Packard – 12
    Median P/E ratio of "Old Guard" Companies: 13
    Is it fair for the New Guard to trade at a median P/E ratio that is 6.5 times higher than the Old Guard?  I don’t think so - it will not last.  It’s not to say that the Old Guard is undervalued, but eventually, the New Guard will come back to earth.  Eventually, the New Guard companies will trade at less than a 25 P/E ratio – it’s the law of gravity in stocks (consider that even Apple trades at a 23 P/E).  Given that, in the case of, that means its P/E ratio will decline by 90% from where it is today.  The question is whether that multiple compression happens because earnings actually grow by 10 times, or because investors get more valuation conscious, or both.  Only time will tell. 

    Disclosure: I am long MSFT, CSCO.
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