Tech Stocks The LinkedIn Bubble Forgot

“Bubble Alert! LinkedIn IPO Doubles” — Wall Street Journal

“Internet Bubble Brings Back Dubious Metrics” – Reuters

“LinkedIn’s Sizzling Debut: Memories of Another Bubble” — The Economic Times

“Social Networks Bubble Away” — Financial Times

If there’s one word that gets investors’ attention, arousing not only fear of catastrophic losses, but also overwhelming greed, it’s “bubble.”

Over countless boom and bust cycles, investors have learned that bubbles will form in any market, from the Dutch tulip craze to the dot-com bust to the recent sub-prime crash.

So when LinkedIn went public, closing at an astronomical 37 times last year’s sales at the end of its first day of trading, fears of a new bubble on the rise spread throughout the market.

The leery eye most investors are casting toward the next wave of technology darlings is understandable; this ain’t the first Internet-bubble rodeo. Only a decade ago, the dot-com bubble burst, and the Nasdaq plunged by 78% in two and a half short years.

Memories of bubbles past

Worse yet, back in 2000 the bubble was unavoidable. The false promise of a new golden age of technology that would make workers vastly more productive, ushering in a sustainable economic boom, propelled all stocks forward. Coca-Cola, that venerable old consumer staple, traded for 60 times normalised earnings. 60 times earnings!

Social networking companies and other Internet darlings are once again partying like it’s March 2000. But does that mean all tech stocks are trading at speculative prices? Not by our reckoning.

In the dot-com heyday, market caps at Microsoft and Cisco both broke the $500 billion barrier. But today’s most well-known social web darlings — Facebook, Twitter, Zynga, Groupon, and LinkedIn — command a combined market value of around $110 billion at today’s trading levels.

Assuming the four other companies joined LinkedIn, went public, and all saw their share prices double, they’d still only be worth about $210 billion in total.

That might form an overheated group, but it would only constitute 10% of the Information Technology segment of the S&P 500. Dot-com era Microsoft and Cisco alone would equal 50% of today’s entire S&P technology segment!

Back in 2000, the emergence of a transcendent new technology, the Internet, boosted valuations on nearly all technology leaders. Today’s transcendent technology — new forms of social media and cloud computing — are pressuring the values of an already established group of technology leaders.

Thus, while companies like Facebook and Twitter soak up media attention, their relative price gains pale in comparison to the stock losses seen at leading companies like Microsoft, Hewlett-Packard, and Cisco.

While most technology companies continue growing earnings, their market values are growing much more slowly, if not shrinking outright. To see this idea in action, look at how much some of the larger U.S. technology companies from 2008 have seen their P/E ratios compress.

Company 2008 P/E 2011 P/E P/E Compression
Microsoft 17.2 10 (42%)
AT&T 19.7 9.3 (53%)
International Business Machines 16.5 14.3 (13%)
Cisco 20.6 12.8 (38%)
Intel 21.6 10.9 (50%)
Oracle 23.1 23.3 1%
Hewlett-Packard 15.9 10.3 (35%)
Verizon 20.0 29.8 49%

Source: CapitalIQ, a division of Standard & Poor’s. Reflective of May 19, 2008 and May 13, 2011 closing prices.

The out-of-this world selling prices seen in social media stocks seemingly aren’t propelling other tech stocks forward. Instead, social media companies seem to be living in their own separate “bubble,” while the largest technology companies see their P/E ratios descend to the cusp of single digits.

The fears surrounding the largest technology companies are often mutually exclusive, yet a wide swathe of these companies have seen their share prices beaten down.   Does that mean they’re due for a rally?  With the level of uncertainty prevailing in the financial markets, that’s not an easy question to answer.

While blazing-hot IPOs will garner much of the media attention over the next year, they’re only one niche of the overall technology space.

Unlike 2000, when the bubble spread far and wide, the shares of some of today’s actual tech leaders appear stuck in the mud, but maybe with good reason.

There are plenty of people who believe smartphones and tablets will sap their growth over the next decade and eliminate PCs. That mobile revolution could prove well-founded; smartphone makers sold more than 100 million smartphones handsets in the first quarter, and growth rates remain astounding.

Whatever happens in the future, you can be sure technology will continue to play and large, and increasing part of our lives. And with investing, the old saying goes there’s always a bubble somewhere. Can you spot it?

This article, written by Eric Bleeker, was originally published on Bruce Jackson, who has an interest in Microsoft, Intel, Cisco and Oracle, has updated it. The Fool has a smart disclosure policy.

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