Stocks and Shares

The thrills and spills of hot tech stocks

"Hot tech or hot potatoes?"
“Hot tech or hot potatoes?”

New technologies are what drive “progress”, for good or ill. But just because a company creates something useful or desirable doesn’t mean its stock is a good investment. That’s because tech stocks tend to come to market with much hype and a rich price. Some work out. Most don’t. Should you invest in the thrills and spills of hot tech stocks? Let’s examine some evidence.

The latest big, hot tech stock to come to market is Snap Inc. (NYSE:SNAP). It owns a sort of social network, called Snapchat, where you can send photos and messages that contacts can view for 10 seconds before they disappear. It’s popular with teenagers and young adults.

Snap was founded in 2011. Those that got an allocation of stock in the IPO (initial public offering) got it for $17 a share (US dollars). That valued the company at $23.6 billion.

Impressive stuff for a business that has so far burned through at least $1.3 billion of cash. Last year alone its free cash flow was negative $678 million, up (or should that be down?) from $335 million in 2015.

It’s one of those companies that burns through ever more cash as it grows its top line sales. Investors are hoping that one day the situation is reversed. In the meantime they’ve just handed management another $3.4 billion to burn through.

The stock opened for trading at $24.48, already up 44% from the IPO price. During the second day of trading it peaked at $29.22, up 72%.

This valued the company at $40.6 billion (its market capitalisation). That’s just a little under the $42.3 billion average market cap of the stocks in the S&P 500 index of large US companies. It’s also more than huge American food company General Mills Inc. (NYSE:GIS), which is currently worth $35 billion in the market, on sales last year of $16.6 billion and net profit of $1.7 billion. (General Mills may not be growing, but at least it sells things that people will still need in decades time from now.)

To put that into perspective, Snap stock fleetingly reached a price-to-sales ratio (P/S) of 100 times 2016 sales, which were $404 million. That’s a staggeringly high valuation for the hope and prayer of continued massive growth and an eventual profit. (And that management doesn’t dilute existing shareholders with big future capital raises, as it runs dry of cash once more.)

Snap Inc. may one day be a huge and highly profitable company. But, like it or not, it’s a hugely speculative investment at that kind of valuation. In fact it makes Deutsche Bank – an investment bank whose stock I recommended as a turnaround opportunity – look low risk by comparison.

Of course Snap’s price peak was brief. The stock now trades at $20.65, which is nearly 16% below the opening price, 29% below the day two peak, but still 21% above the offer price. It leaves the company valued at $28.7 billion, which is still 71 times last year’s sales. It’s the late ‘90s tech bubble all over again.

Obviously it’s already been a roller coaster ride, so far lasting just nine trading days. Clearly the hope of investors’ is that Snap Inc. will end up being some kind of repeat of Facebook Inc (NASDAQ:FB), the big daddy of social networks.

Facebook made a net profit of $10.2 billion. These days it’s a monster cash machine. On the other hand Twitter Inc (NYSE:TWTR) – another social network – lost nearly half a billion dollars.

Snap clearly has a lot to do to justify its price tag. It’s need a load more revenue and to actually, one day, turn a profit.

Maybe it will, maybe it won’t. But it got me thinking about hyped up tech stocks in general.

Snap’s massive valuation for a cash burning business is a reminder that technology may change but human nature doesn’t. People still get swept up in waves of hype and market mania – mostly ending in substantial disappointment. (Think South Sea bubble, Dutch tulip mania, US railroad mania, British canal mania, etc. etc. etc.)

But what about some evidence from the present day? How did investors in hyped up tech IPOs do in recent years? I decided to take a look.

First I came up with a list of companies that have listed in the tech sector in recent years. It’s not a comprehensive list. It’s just the stuff that I recalled from memory.

Since I don’t usually follow tech stocks closely – for reasons that will become clear – if I’ve heard about it then it must have been surrounded by loads of hype. Here’s my list of nine, which goes back five and a half years, and a brief description of each:

  • Groupon (NASDAQ:GRPN) – online buying and selling
  • Facebook (NASDAQ:FB) – social network
  • Twitter (NYSE:TWTR) – succinct social network
  • GoPro (NASDAQ:GPRO) – video cameras
  • Alibaba (NYSE:BABA) – online buying and selling
  • Etsy (NASDAQ:ETSY) – online buying and selling
  • Fitbit (NYSE:FIT) – fitness gadgets
  • Square (NYSE:SQ) – payments
  • Snap (NYSE:SNAP) – ephemeral social network

[I would also have included LinkedIn, an online professional network, but it was bought by Microsoft.]

These all happen to be companies listed in the US, although Alibaba is Chinese. The question is: how have these stocks done since they were listed on the stock market? How many were winners and losers?

One caveat here. I’m going to work this out using opening prices on the first day of trading for each stock. The IPO offer prices could have been a bit lower – in fact they probably were in many cases (underwriting banks want to make sure the deals get away). But still it’s interesting to see how these stocks have done since they started trading.

Below is a summary which shows each one in the order from when they were listed on the stock market. It shows the opening price, the price at time of writing, and the capital gain or loss as a percentage.

First off you can see there were three winners and six losers. In other words, two thirds of these stocks have been bad investments.

The average loss so far was almost 11%. Facebook has been a huge winner – after a wobbly start. It’s up 231%.

That’s significant, because if you’d bought all the others but missed out on Facebook the average return for the remaining eight is a loss of 41%. This illustrates the heightened risk of dipping your toe into hot tech stocks. It’s easy to get burnt by missing the relatively few winners.

Let’s look at this a slightly different way. What if you’d invested $10,000 into each stock and held onto it until today. How would that look?

Since Facebook is such an outlier I’ve included a summary of all nine stocks, and the eight excluding Facebook. Also, because Snap Inc. is so new, I’ve shown how it looks for the earlier seven (also excluding Facebook).

It’s clear from these numbers that most of my list – the hyped stocks that I could recall – have done badly. If you’d picked a few, chances are you’d have lost a lot of money. If you’d invested in all of them you’d still have lost money.

And remember, this is during a massive bull market in US stocks. A situation where a rising tide is supposed to lift all boats. What happens if and when the market crashes? These will sink even lower.

Tech companies often produce useful or desirable products and services. But buying highly priced tech stocks is a risky business. Remember, what makes sense at one price can make little sense at another.

I’ve only given a snapshot here. But I hope it illustrates the thrills and spills of hot tech stocks. Even the stocks of highly successful businesses, if bought at the wrong price, are unlikely to turn out well for the investor. Most of them turn out to be hot potatoes that get mashed.

Stay tuned OfWealthers,

Rob Marstrand

Our goals are simple. We want to help private investors do two things:

Build wealth. Invest with success.

Twice a week we help thousands of subscribers who share these goals with our free publication, the OfWealth Briefing.

As well as everything published on our website, subscribers receive additional exclusive comment and analysis that is unavailable anywhere else.

New subscribers will also receive several free special reports as soon as they join up. Click on the link below for more details and to start receiving your premium OfWealth content.

Click Here to Subscribe

Previous ArticleNext Article
Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.