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Apple and Facebook post strong results – are tech stocks a buy?

Facebook Inc (NASDAQ: FB) now counts half the world’s internet-connected population as a user. Reporting its quarterly profits yesterday, the company boasted a huge profit increase of nearly 200% to just under US$650 million. Advertising revenue was up strongly – over 80% – and earnings from mobile ads comprised a greater share of revenue – almost 60%. Increasingly, mobile is the most important platform, and it’s worth noting that the company boasts 1.28 billion monthly active users. Based on the most recent quarterly figures, Facebook is making about 50c per user per quarter – or around $2 per user each year.

Meanwhile, Apple Inc (NASDAQ: AAPL) also posted some strong results. While the media is focussing on the nearly irrelevant share split, the real story is that the company sold a bunch more iPhones than the market (or the analysts, at least) expected, shifting 43.7 units in the quarter. Another positive for investors is that the company has decided to buy back an additional $30 billion worth of shares. A combination of that, and the unexpectedly positive sales momentum has sent shares soaring in after-hours trade. These impressive sales figures were in large part due to the partnership with China Mobile boosting sales to the world’s most populous country.

But what does all this mean for Australian investors? Firstly, it should take some urgency out of the tech stock sell-off, at least until markets forget about these great results (in a couple of weeks, is my guess). Secondly, it gives us yet another massive sign about consumer behaviour – people (all over the world) are buying smart phones and using them to access Facebook.com (and other online platforms).

How can Australian investors profit from that trend? We’ll get to that… First, let’s hear what a couple of superinvestors have to say about tech stocks.

David Einhorn says that “we are witnessing our second tech bubble in 15 years” and his fund Greenlight Capital is short a number of (undisclosed) tech stocks as a result. To be fair, the recent euphoria surrounding XERO NZ FPO (ASX: XRO) does indicate ridiculous optimism, if not a bubble. It brings to mind Peter Lynch’s warning that: “If I could avoid a single stock it would be the one in the hottest industry, the one that gets the most publicity, the one that every investor hears about it in the car pool or on the commuter train, and — succumbing to the social pressure — often buys.”

However, before you get too bearish on tech stocks, it’s worth considering the more tempered advice of Warren E Buffett. “Stocks ought to be higher every 10 years,” he said recently. On the subject of tech stock prices he mused that, “there are very few tech stocks I would want to buy at the prices they sell for… but it’s not remotely like the bubble that existed 15 years ago… we’re not seeing total craziness or anything of the sort.”

So there is good reason to be cautious about tech stock valuations, but a discriminating investor may still find a bargain. For example, mobile advertising company Mobile Embrace FPO (ASX: MBE) is set to benefit from this trend. The company is priced for growth, and a director did dump over $1 million worth of shares recently. However, the company is likely to produce profit and free cashflow of over $3 million in FY 2014. While the company is reasonably expensive with a market cap of almost $85 million, it is by no means ridiculous compared to other hopeful tech companies.

For example, unprofitable cash drain Moko Social Media Ltd (ASX: MKB) is up 7% today, boasting a market capitalisation of about $95 million. The company has yet to post a profit or any free cashflow whatsoever, making valuations completely speculative. I think it’s likely the company will one day be profitable, but I don’t know when that will be. I wouldn’t invest until the prospect of future capital raisings is off the table.

Foolish takeaway

As Warren Buffett says, tech companies are not uniformly trading at ridiculous prices, although many are expensive. While companies like Apple Inc and Google Inc look to be reasonably good value, by and large, tech companies are on the pricey side. In my opinion, investors should look to little-known growing small caps to beat the market. There’s no need to get carried away with the next big thing.

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Motley Fool contributor Claude Walker (@claudedwalker) does not own shares in any of the companies mentioned in this article.

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