Prices of social media and 3D-printing companies climb new heights.
15 January 2014. Twitter rose by 80 % on the first day of trading. LinkedIn, Facebook and Pandora Media rewarded investors last year with profits of 120 % to 200 %. Not surprisingly, people are making parallels to the past technology bubble at the turn of the millennium. The high-flyers, however, are hiding the fact that the sector as a whole even has catch-up potential compared to the wider market and that the top companies are undervalued. The tip of the iceberg is therefore deceptive once again: there is no danger below the waterline, however – quite the opposite.
The jump in share prices of some Internet companies are making people sit up and take notice. Price-earnings ratios (P/E) in double digits show that investors are ready to take on considerable risks again to participate in the Internet boom. The business models of some growth shares certainly have the potential to go beyond conventional limits and hence set new standards in terms of growth. This requires plenty of imagination, however, which is well known for being associated with uncertainties. “The price of some companies therefore appears very adventurous when taking account of classic valuation criteria such as solid balance sheets, high cash-flows, impressive equity ratios and dividend continuity. Nevertheless, there are plenty of alternatives to the high-flyers from the social media and 3D printing sector. These are at much more attractive price levels, without having to make compromises as regards the growth rate,” as Anders Tandberg-Johansen, Head of Global Technology and Fund Manager of the DNB Technology Fund, knows.
New economy with fantastic valuations
Two clusters have formed within the technology universe: on one side the “New Technology Club” featuring the leading social media platforms and the highly innovative 3D printing firms. On the other side the established top companies like Google, Apple and Samsung.
A look at the most expensive shares measured by the P/E ratio shows that the fears of an exaggeration are not unfounded. It is limited to a small number of companies, however. This could include Salesforce, LinkedIn, Amazon, Netflix and 3D Systems, which are visionary companies with good future prospects. Whether or not this justifies a P/E ratio of 160 in the case of Salesforce, may be critically questioned, however. It will also be interesting, for example, to see whether Netflix can maintain the enormous growth rate of users to service its non-balance sheet liabilities of USD 6 billion. The Internet radio company, Radio Media, is currently being traded at a price/sales ratio of more than 11. The question of what the effective entry hurdles to the Internet radio sector are, cannot be answered conclusively. Facebook now has more than a billion users worldwide and has developed into a fantastic mobile advertising tool, only young people are slowly losing interest in this platform. “We cannot say with any certainty today that Facebook & Co. will face huge problems from this. But the probability that it will come to this is definitely not accounted for in today's prices. That should make investors think,” summarises Anders Tandberg-Johansen.
Solidity and high growth can be found elsewhere
In contrast to the high-flyers, the industry giants like Google and Samsung, but also Opera Software and Gameloft, almost have a defensive character. They are ultimately distinguished not by their growth dynamics, but by their much more favourable valuation level, namely an adjusted P/E ratio of 20 or less. Opera Software (26) and Gameloft (29) are priced slightly above. In addition, most of these companies hold net cash positions. By comparison, Salesforce and LinkedIn cost 10 times their annual sales, whilst 3D printer shares have to be bought at 17 times their current annual turnover.
Samsung and Google – two growth pearls for little money
The best example is Samsung, which currently makes up the biggest item in the DNB Technology Fund. Its P/E ratio is a meagre 7. If you subtract the cash items, it is even much lower. It is indisputable that margins in the profitable smartphone sector have come under pressure. “Despite the necessary caution, the scepticism of investors seems wildly exaggerated to us. From a risk/earnings perspective, Samsung is therefore an obvious purchase,” Anders Tandberg-Johansen is convinced.
This category also includes Google, which with its search engine business and profitable online advertising, YouTube, the Android operating system and new projects, is undoubtedly the best positioned Internet company worldwide. Its core advertising business is growing over 20 % a year. The share is only valued at 20 times the 2014 profit, without the company value having been adjusted by its large cash position. Google is also investing huge sums in research and development totalling USD 6 billion. If they restricted themselves to maximising profits, then it would be possible to buy the share at an incredibly low price. Yet Google is thinking beyond the next five years and is investing in sustainable growth. But even Google is not immune to economic setbacks, which has to be taken into account with any tech investment.
Conclusion: Still plenty of room for growth
Even if a certain number of Internet shares are valued at the level of a bubble, then the same cannot be said of the entire technology sector. Quite the opposite – the sector did not manage to beat the wider market last year, which is why intelligent alpha strategies were needed. As a result, there is still plenty of room to go higher.
“We feel comfortable with our positioning and are sticking to our GARP strategy, which attributes a higher significance to the valuation of shares. In this respect we are backing companies whose key performance indicators impress us. We are keeping our hands off the high-flyers,” says Anders Tandberg-Johansen, “because there are simply better investment options from a risk/earnings perspective.”
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