Financial Comment - Are high-tech stocks overvalued?

Are we seeing a "stretch" in equity valuations?

About two months ago, in mid-May, we wrote about small, high-tech American stocks that had entered negative territory and many analysts wondered aloud whether that drop was due to overstretched valuations. There were also worries at that time that a general market correction was coming. Shortly after that, the decline of smaller stocks turned into a recovery and the whole U.S. (and Canadian) stock market has since done quite well. However, concerns about high-tech American stocks being overvalued have not fully dissipated.

A couple weeks back the U.S. Federal Reserve Chair Janet Yellen said that "equity valuations of smaller firms as well as social media and biotechnology firms appear to be stretched." This drew such stocks as Twitter and Facebook down by slightly over 1% each on July 15, 2014. At that time, Facebook’s trailing 12-months P/E was 87 times, while Twitter’s trailing 12-months net profit was (and remains) negative, which is strongly reminiscent of the 2000 Internet bubble. According to the BofA Merrill Lynch Fund Manager Survey for July, 21% of global asset managers see stock markets as overvalued, the highest level since 2000.

At the same time, signs of improving economic conditions in the U.S. support the argument that the U.S. economy is getting stronger, leading to a belief that the strength of high-tech and social media stocks has one simple explanation: expectations for higher profit growth. Facebook’s stock has now grown 11% from last Friday on the news that earnings jumped 138% in the second quarter of 2014 as compared to year earlier. The stocks’ P/E multiple just before the second quarter financials came out was 92 times while based on the new net income it came in at a more reasonable 77 times. Analysts forecast that Facebook’s P/E based on its 2014 net income will go down to 59 times while its forecast 2016 P/E is 31 times. While not exactly cheap, these forward multiples are not so expensive for a fast growing company. With this kind of earnings growth, expect to see Facebook shares to maintain their strength.

By: Ukrainian Credit Union Limited