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Are Australia’s tech stocks in a bubble?

The last six months has been a great time for investors in technology stocks. Flight Centre (ASX: FLT) is up 80% this year, Seek (ASX: SEK) is up 77%, Carsales (ASX: CRZ) is up 32% and recent IPOs from Freelancer (ASX: FLN) and Twitter (NYSE: TWTR) have rocketed above their listing price in the days following the float. The frenzied excitement about tech stocks has caused some analysts to question whether we are heading into another bubble.

While companies such as Flight Centre, Seek, and Carsales are generating record profits and growing revenue, the concern mainly surrounds the sky-high valuations given to tech companies generating little to no profit and being priced on potential.

This is similar to what happened during the 2000 dotcom boom where some companies were being valued, based on metrics such as page views and connections to users, without any way of monetising their service. An example of this is the $3 billion offered by Facebook (NASDAQ: FB) for the purchase of disappearing-photo sharing service Snapchat.

Snapchat has a huge and growing user base, however it is yet to generate any revenue and there appears to be limited scope for advertising in the app. Facebook’s interest is more strategic than financial, but the question must be asked how much the app is actually worth if the owners turn down $3 billion.

Similarly, newly listed Freelancer.com rose from 50 cents to a high of $2.50 in its first day of trade, finishing the day at $1.60. Admittedly there are relatively few shares of the company available for purchase; however after its first day of trading its market cap had risen from $218 million to $700 million.

Freelancer has forecast revenue of $18.3 million in 2013, with $1.6 million in earnings before interest, tax and amortisation, giving it an earnings per share of 3.7 cents for a price to earnings (PE) ratio above 45. This compares with a PE ratio of 20 for Flight Centre, 14 for Seek.

Twitter, meanwhile, has even further stretched metrics. Having debuted at $26, the share price quickly doubled before pulling back to Tuesday’s price of $41. Twitter was therefore valued at $25 billion but has accumulated losses of over $300 million over the past three years.

Investors seemingly rated the company on price-to-sales (PS) ratio instead of price-to-earnings, however at a PS ratio of 22 it was roughly double that of Facebook and LinkedIn (NYSE: LNKD), which themselves had abnormally high PS ratios at listing.

Foolish takeaway

From a distance, it appears as though valuations for newly listed tech companies may be getting ahead of actual company performance. The Nasdaq index of technology stocks in the US is at a 12-year high and a number of analysts are starting to predict that a correction could be on the cards for some stocks that have run too far.

Australian stocks such as Flight Centre and Seek could be in for a correction too, however forecast revenue and profit growth should limit the downside. Companies lacking the profitability and dominance of such companies have more to lose and can be expected to be sold off heavily if market sentiment turns suddenly.

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Motley Fool contributor Andrew Mudie does not own shares in any of the companies mentioned.

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