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Avoid these 3 tech stocks

Investors who were around for the dotcom bust in 2000 will remember the sky-high price to earnings (PE) ratios of the Internet companies at the time. The share price of many Internet companies rose as a result of the potential size of the industry/market or the volume of traffic to the site rather than how the company monetized the attention the site received.  While this isn’t necessarily the case for today’s dotcom companies, the likes of REA Group (ASX: REA), Carsales.com (ASX: CRZ), Wotif (ASX: WTF), and Webjet (ASX: WEB) have generally underperformed the market recently, leading to questions about the prospect of further falls.

REA Group is the exception, having outperformed the ASX 200 by over 70% in 2013 so far, and has quadrupled in price since 2011. REA is predicted to deliver annual earnings per share (EPS) growth of around 20% in both of the next two years, however at the current share price of $41 and a 2014 PE ratio of 39, some expect that significant falls might be on the horizon. Brokers have a target price of between $33 and $36 on the stock which would imply a 20% downside at the current price.

Carsales.com has had an interesting year so far, shooting up over 25% between June and September only to retreat back around 8% since to trade at $10.90. It is trading on a 2014 PE ratio of 26, well below that of REA group, however recent commentary about manufacturers pulling ads from the site may lead to the company missing earnings expectations this year. This would be bad news for the share price.

Wotif and Webjet operate in overlapping sectors, with Wotif offering online accommodation booking, while Webjet allows users to book flights and accommodation. Wotif’s share price is down over 20% from its 12-month high as EPS dropped 12% in 2012-13 as expected growth from acquisitions was not realised. Regardless, it still trades on a 2013 PE ratio of 20 with low EPS growth of around 5% expected this year. Increased competition from the likes of Webjet and larger, international competitors isn’t helping either.

Webjet posted mediocre 2012-13 profit growth of 6% and the share price subsequently suffered, dropping 30% from $5 mid-year to $3.50 now. Estimates place EPS growth at between 15% and 20% for the next two years as the company integrates recent purchase Zuji into the business. Much hinges on the successful integration, and the 2013 and 2014 PE ratios of 16 and 13 respectively sees the company at around fair value taking into account the implementation risks at the moment.

Foolish takeaway

Some of Australia’s largest listed tech stocks are trading at or well above fair value. Significant EPS growth looks to be difficult in the current economic environment and the four companies above will suffer sharp share price falls should they fail to deliver on guidance and estimates. REA group potentially has the furthest to fall, however increased completion from local and international websites may hurt Webjet and Wotif more in the short term.

As well as being overpriced, these tech stocks generally offer very small dividend yields due to the capital investment required to stay at the head of the pack. Investors more interested in high, growing yields should discover The Motley Fool’s favourite income idea for 2013-2014 in our brand-new, FREE research report, including a full investment analysis! Simply click here for your FREE copy of “The Motley Fool’s Top Dividend Stock for 2013-2014.”

More reading

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Motley Fool writer Andrew Mudie does not own shares in any companies mentioned in this article. 

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