Monday, June 22, 2015

The Coming Tech Crash

Predicting a Tech Crash isn't hard.  They happen ever 5-10 years like clockwork.

We are due for a correction in the tech sector.  I can say this and sound like a genius, but really it means nothing.  New technology stocks always follow a pattern of initiation, growth, euphoria, overbuilding, and correction.   And this has been going on for hundreds of years.

Railroads were the first "tech" stocks.   You might not think of railroads as sexy high-technology, but back in the day, they were pretty amazing.  It used to take days to ride or sail from New York to Boston - now it could be done in a day, or overnight.   It was like Captain Kirk's transporter beam, to people in the 19th Century.

After the Civil War, railroads expanded, across the continent, and while some were highly solvent and profit-making enterprises, it didn't take long before overbuilding occurred.  People started up railroads that went from nowhere to nowhere, and there simply weren't enough paying passengers to justify the cost of the lines.  Before long, the market crashed.   The stronger railroads bought up the assets of the weaker, and there was a huge consolidation of lines.   Life went on, some made money, a lot more lost it.

Automobiles followed a similar tech boom/bust cycle, with hundreds, if not thousands of companies starting up to build cars, and after a huge bust, only a few major players soldiering on (even GM almost went bankrupt - for the first time - during those early years).  If you invested in the Briggs Detroiter, chances are, you lost your shirt.

Airplanes were another example of gee-whiz high tech.  And it is a lot less harder to explain why flying through the air seemed like a pretty amazing thing to do, for earthbound humans of the early 20th Century.  As Neil Shute Norway illustrated in his book Slide Rule, perfectly successful companies can go on for years and years losing money and not returning profits to shareholder, before they eventually go bust and are bought out by a competitor.   As he illustrated, his company Airspeed never really made any money, and the original investors, if they had hung on for the full thirty-year ride, would have gotten their money back (and not much else) when the company was sold.   Given the amount of inflation, one wonders why anyone would invest in such a company.

The personal computer business was booming for many years, but by the late 1980's, companies like Apple were hurting - they even fired Steve Jobs and suspended their dividend!   Hard to believe that is the same company that today, people think rules the world.

In 1995, we saw a lot of hardware companies collapse, as they geared up to sell components for the new computers expected to be sold when Windows 95 came out.  Problem was, most people thought Windows 95 was over-rated and there was no rush to change out old computers for new ones - at least not right away.

We also found out that hardware (everything from displays to disc drives to processors and memory) were commodity items and as such, profit margins started to get thinner and thinner as computer prices plummeted.   A $499 Dell computer had $99 worth of Microsoft Software in it - the largest and most expensive single component, whose incremental cost of production was nearly zero.   To those from the era of big mainframes, where the cost of components was the big deal, this was a wake-up call.   Electronics have almost reached the disposable stage, if not already so, and software is where the money is at.

The first "dot com" collapse occurred about a decade ago, when things like went bust and in a big way.   We all thought that these "websites" were a big deal, but it turned out, no one was making any money at them, and the stocks were highly over-valued.

Fast forward another decade, and now online companies are the "next big thing!" with Social Media leading the way.   We are a Facebook and Twitter generation we are told, but oddly enough, most of these new era companies are either losing money, not making much money, or not making enough to justify their sky-high stock prices.

Amazon, for example, the 600-lb. gorilla of online retailing, has a stock price of over $435 but is losing about a buck a share every year.  And this is one of the more successful Internet companies out there.   In order to justify this stock price, Amazon would have to from losing a buck a share to making twenty.  This is indeed a tall order.   Amazon may make money in the future, perhaps the near future.  But to go to 20 dollars a share?   Maybe not anytime soon.  And the reason is simple:  Anyone can play the online retailing game, the costs of entry are the six-pack of beer you have to buy some broken-down IT guy to setup your website.  

Don't get me wrong, Amazon is a great company. I buy shit there all the time.  The stock is just wildly overpriced.

On the social networking side, Linked-In is at least making money - or was making money for a while.  Today, they are losing 37 cents a share and there has been a bit of mild sell-off, lowing the share price to about $216.   Motley Fool says to hang on to your Linked-In stock, which is a sure sign to sell it (when in doubt, do the opposite of whatever the Motley Fool says).  Again, to have a rational P/E ratio, Linked in would have to go from losing money to making ten bucks a share at this price.   But I think their site has plateaued in users and relevance.  If they can't make money at this yet, when will they?

Apple is both a hardware and software maker, and they realized that you can charge five times or more for a product, if you can make your product the "must have" status accessory. At about $127 a share and a P/E ratio of 15.77 and a dividend rate of 1.64%......  might not be a bad buy!     It is interesting that the company is finally making a reasonable profit (relative to the share price) and even paying dividends.  However, perhaps the market is saying Apple has nowhere to go at this point - and that the iWatch might not be a big seller.  Today, it is a good value stock, despite my misgivings about the company.  But tomorrow?  That is the kicker.  So long as people will keep paying for that Apple logo on their smart phones and Apple can get $600 a phone, it's all good.   The moment it stops, or people realize a similar phone can be had for $99, well, things might go South in a hurry.  And it has happened before to Apple, back in the 1980's, as I noted above.

Facebook, of course, is the big daddy of social networking, and it is profitable.  The share price is presently about $85 a share, and with profits of about a buck a share, has a P/E ratio of 85 as well.   For a social networking company, this is as good as it gets.  But like with Sir Nevil Shute's Airspeed, you won't make any money in the long haul, as it pays no dividends.   In order for the share price to be rational (a P/E ratio of around 20 or so) they would have to quadruple or quintuple profits, which is problematic, as the more you try to wring money out of social networking, the more you lose users.  And Facebook is losing users - the young demographic in particular - which is troubling for the long run.  These things are like fads, and many folks, other than the hard core users, get bored and move on with life - or get creeped out by how intrusive, fake, and weird social networking really is.

Twitter is always talked about in the media.  Sadly, usually this in the context of someone saying something really stupid on Twitter and then getting fired or having to go on the talk show apology tour.  It sells for $35 a share and loses a buck a share every year.  If they could make $1.75 a share, the stock price would be rational.  Sadly, they just fired their CEO in an apparent shuffle, claiming that he is not doing enough to keep the brand fresh and expand the number of users.   While the media hypes Twitter (people who work in the media like to use it) the number of users is really quite small, maybe a quarter billion, based on self-reported data (so cut that number in half, for the real deal).

Netflix is another darling of the tech set, and at $675 a share, is wildly overpriced, with a P/E ratio of over 175.  They are making about $4 a share right now, but would have to expand to a mind-boggling $33.75 a share to make the current share price make any sense.  The problems for Netflix are multifold,  They made good money starting out, as the only online movie streaming service, and with a huge library courtesy of the STARZ contract (a loophole akin to Bill Gates' IBM DOS agreement) they had a great product at a very low price.

But regulations and market conditions could wipe out Netflix overnight.   The studios and other content creators are pulling back on content, or starting their own sites.  Hulu and YouTube are not sitting idly by - you can stream video from both, and YouTube now rents major movies for a couple of bucks each.  First to market is often last in the marketplace.

In response to this, Netflix has gone into the move/television business, creating its own content out of necessity, sometimes hitting it big with things like "House of Cards" and other times, well, spending a lot of money for nothing.  But this is the way they will have to morph, to survive.  Unfortunately, competing studios and television networks will be less likely to license content to what is now a competitor in their field, not just an adjunct to ie.

On the plus side, Netflix finally improved their user interface, which was slow, buggy, and annoying.  It is far less annoying, now, slightly faster, and less buggy.   But the stock is still wildly overpriced and the future of the service is anything but clear.

Angie's List, with a share price of $6.33 and earnings of minus seven cents, has been on everyone's death watch list for some time.   Don't let these small numbers fool you - they are in the same boat as many of the others above.  They would have to go from -7 cents to +32 cents to make the share price make sense.  In other words, they are about in the same shoes as Twitter and Linked-In, but without such a compelling "must have" rating site.   Free sites like Yelp and Trip Adviser and whatnot, obviously are far more popular than this pay-to-play site, and the criticisms of their business practices are legion.

The list goes on and on, of course.  These are just a few major players you have heard of - the ones that should be at the top of their game, but are just barely getting by.  Other players, such as Groupon, Zynga, and ZipCar have already arguably bit the dust. 

There are some oddballs out there, such as King, who sells the Candy Crush Saga game, trading at $14, with a P/E ratio of about 7 (!!) and actually paying dividends and earning money.  But the low share price might be the market's way of saying this one-trick pony may soon lose it all, as people morph to "the next big thing!" in online games (and if you doubt this, tell me where all the angry birds went, or for that matter, the people in Farmville).  This exception proves (tests) the rule, and perhaps points out that P/E ratios and dividend yields aren't everything, except when you have no profits, in which case they are.

So what will happen to these companies?  Will they go out of business?  Bankrupt and close their doors?  Hardly.  But I suspect the share prices could "adjust" in the future (when is anyone's guess, of course) unless profits increase dramatically, which I doubt they will.   A lot of these companies, like most tech companies, or like Airspeed, will likely never make money for the long-haul investor.   People who gamble on the share price - which is set by public sentiment and little else - may be able to buy low and sell high.  But for every lucky gambler, there are bound to be three losers.  The house always wins.

The point is, for the small investor, these are not "investments" and you aren't "missing the boat" by not plowing your money into these wildly speculative and over-valued investments.   

So why are the share prices so high?  Well, think about it.  When you turn on the television, go to a news website, or read the paper, what do they talk about?   Do they talk about Stanley Tool, which has a P/E ratio of 22 and a dividend yield of nearly 2%?  Hell, no.  That's an old and boring company that just "makes things" and makes profits, year-in and year-out, and then cranks out dividends.   If you bought the stock years ago (as I did) you have doubled your money by now - and had a tasty dividend on top of that.

But you'll never hear the media talk about boring stocks like that.  Exciting stocks - who do IPOs and whose share price goes up and down dramatically - are always talked about.  And anything "high tech" is talked about, because it feeds this (bad) idea that you can "get in on the ground floor" on a new technology.

But as I noted in my last posting, there was no "big idea" at Microsoft back in 1980, and few people would have wanted to "get in on the ground floor" on a small software company that had a lucrative contract land in its lap.  It just isn't that easy to spot winners in the marketplace, without a working time machine.

If you want to gamble on these stocks, fine.  Just realize it is gambling, and than you could literally lose all of your investment.  It makes no sense to put more than a token amount of money into any newly emerging tech sector.   Picking the winners is very, very hard to do!