In my Money Week column this week, I've been looking at the bubble in tech stocks. Here's a taster.
Right now, everyone in the markets is worrying about bubbles. It might be commodity prices, it might be bonds, it could be gold, or it could be the emerging markets. They are all up strongly in the past year. They all look as if they might have over-reached themselves.
But one distinguishing characteristic of a bubble is that no one really notices it. If everyone is complaining about the price of a particular type of asset, it is probably in perfectly good shape. It is the bubbles you haven’t seen that are likely to catch you out.
What are they? In a replay of 1998 and 1999, it might well be technology. Amazon is trading on a price earnings ratio of almost 70. Apple is now the third biggest company in the world. Google just keeps going up in price. And Facebook, if it ever comes to the market will be valued at billions.
And yet despite the explosive growth of the internet economy, all the old problems remain. Business models are flimsy, the barriers to entry are wafer-thin, and the technology moves so fast, it is hard for investors to make any money.
When the post-credit crunch bull market comes to a screeching halt, as it inevitably will at some point, it well be a technology crash that bring it down.
No one would deny that internet is now a huge business. That was underlined by a report by the Boston Consulting Group published last month. It found that in the UK alone, the online economy was now worth £100 billion a year, and accounted for 7.2% of GDP. If it was a separate economic sector, it would be bigger than construction, transport or the utilities.
Britain is not particularly advanced in its take-up of technology. What is true in this country will be true in every other advanced economy as well. This is a huge and growing chunk of the global economy.
It is absolutely right, therefore, that the companies that dominate the space should be sought after by investors. Anyone looking for long-term growth is going to want to own a slice of the leaders of the technology boom. Otherwise they risk getting left behind.
But hold on. Just because a company has good long-term growth prospects does not mean it is worth absolutely anything.
Take Amazon, for example. It was one of the pioneers of online retailing, and remains the best brand in that industry. I’d be surprised if there was a single reader of this magazine who wasn’t also an Amazon customer. Its latest figures were terrific: sales were ahead by 16% and profits were ahead by 39%. No doubt it will have a great Christmas. Even so, its share price has gone crazy. They have jumped from $25 a share in 2005 to $170 now. It is trading on multiple of 69 historic earnings, and 49 times the forecast earnings for next year.
Or take Apple. Sure, the iPhone is a big hit, and the iPad has been making a lot of noise. In the last five years it has got just about everything right, and there is probably no other business around that has so many devoted customers. Even so, there must be a limit to what it is worth. The shares are up by more than 50% this year alone. With a market cap of $290 billion, it is the second most valuable American business. It is the third most valuable company in the world, after Exxon Mobil and PetroChina. This, remember, is a company which, while it dominates the market for MP3 players, currently has just 4.1% of the mobile phone market, and slightly over 5% of the global market for personal computers. Those are hardly dominant market positions – but you would hardly guess that from its share price.
Much the same could be said of Google, or Facebook, or many smaller technology companies. They are good businesses, in a fast-growing sector of the economy. But they are also hitting crazy prices.
The trouble is, all the old problems with technology and internet companies remain.
For starters, there are still far too few barriers to entry. The days when a few bright Harvard students could start a website that would blow apart the industry, in the way that Mark Zuckerberg did when he started Facebook in 2004, may be over. Then again, they may not be. This is still an industry in its infancy. It is very easy for a few bright people to turn the web upside down with very little money to play with. That is great for them, and it is what makes high-tech so exciting. But is it very worrying for shareholders in the established companies. It is just too easy for a young entrepreneur to come along and blow you away.
Next, there are still relatively few sustainable business models. The online retailers make money, but often only by squeezing their suppliers to the bone. The internet is the most ruthless price comparison device ever invented, and one consequence of that is that margins will always be wafer thin. Businesses like Google may have a great advertising franchise right now – but there is no limit to ad space on the web in the way there is in the physical world. In truth, all online business models remain very flimsy.
Lastly, the technology moves so fast it is very hard for shareholders to make money. The founders and the venture capitalists who back them usually do pretty well. But by the time a company gets to the quoted market, its best days may already be behind it. It may never get to the stage of paying out steady dividends. Even Microsoft only paid its first dividend in 2003. Neither Google or Amazon have ever paid a dividend, nor are they planning to do so. By the time they do, they will probably look as far past their sell-by date as Microsoft does.
In reality, the tech rally looks overdone. It is bound to come shuddering down to earth again some time soon. And when it happens, it may well prove a trigger for a wider market correction.