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About Me

Darren Winters is a self made investment multi-millionaire and successful entrepreneur. Amongst
his many businesses he owns the number 1 investment training company in the UK and Europe.
This company provides training courses in stock market, forex and property investing and since
the year 2000 has successfully trained over 250,000 people.

Wednesday, 30 April 2014

The Tech Boom Then & Now

The Tech Boom Then & Now

Who famously said that, “profits are for wimps!”  You could easily be mistaken for believing that this must have been uttered by some avid socialist. Wrong!  A clue; cast your minds back to the early millennium tech boom. Indeed, this was the prevailing view and said many times by the then budding new economy entrepreneurs.  The owners of these new businesses argued that in this modern world of technological development the traditional methods of evaluating businesses were completely outdated and that profits were for wimps.
But shouldn’t the object of a business remain the same, namely to make a profit, irrespective of whether the entity was a builder of railroads in the 18th century or a provider of technology in the new millennium.
 Back then, the boys with MBA's and shiny shoes from the Ivy League business schools somehow bamboozled investors with impressive business plans. They put forward compelling arguments about forsaking company profits in the foreseeable future for instead the greater good of focusing their goal on increasing market share.                                                 
It was a rather devious plot, if investors seemed weary about the viability of the business, they would be patted on the back and told not to worry; after all who cares about foreseeable profits in short term, when the goal of the business is world domination. Be patient; forsake rewards in the near future for huge rewards in the long term.  The business strategy seemed credible, moreover it tapped into one of the most powerful human emotions of all; greed. Investors scrambled over themselves in desperation to buy anything that had an internet sounding name. Many of them didn’t even understand the business activities, let alone conduct some preliminary research into the financial credibility of the company’s share they were buying. 
But who cares, just buy and hold, then sell next month and bank the profits. It seemed like a no brainer with everyone jumping on the bandwagon.

As the saying goes the rest is history.  The technology bubble ended like so many previous bubbles before it; with a burst, a sharp correction in technology share prices followed by a recession.  Like in all investments, it’s all about timing, knowing when to buy and when to sell. Only a lucky few people were fortunate enough to get out at the right time. The result being that a few people made a lot of money, but even more people lost even more money.

Fortunately, there were a few voices of reason during the internet mania, as it was dubbed back then. The author of “Irrational Exuberance”; Robert Shiller, an economist at Yale University argued in early 2000 that there were many similarities with the technology bubble back then and with Britain’s railway mania in the 1840’s. Would be railway millionaires raised large amounts of capital on the stock market to finance railway construction. Most railway companies never made a profit due to the fact that over investment resulted in overcapacity, which resulted in many going belly up.

So, now in 2014 is the technology sector in a period of “irrational exuberance?”  I would argue definitely!  Moreover, the correction coming is going to be bigger this time around. Regretfully, investors have not learned from the previous correction.  Put simply the objectives of a business is to make profits. Getting back to fundamentals is desperately needed and the traditional methods of evaluating a business are more so valid today in the technological sector.

Let’s revisit some old fashioned ways of evaluating the viability of the tech sector.  For example, the Price-Earnings ratio (PE) is a useful tool in the investor’s box for assessing whether the current market price for a stock is trading at a fair value.

The PE ratio is relatively a simply ratio to calculate; divide the current market price of the share divided by its annual earnings (EPS).  As a rule of thumb, when the PE ratio is high it would indicate that investors are optimistic about the future earnings of a company compared with a lower PE ratio.

Face book’s current PE ratio is 71, which means that the stock is trading at 71 times its earnings per share. To give you some perspectives, the average Dow Jones industrial company trades at only 13 times EPS. Investors normally feel comfortable with a PE of 20.  So Facebook’s PE ratio is sending up a big red flag. Investors are overoptimistic about the future earning potential of the company; the current share price is overvalued.

Let’s examine another useful figure, market capitalization.  This is the total market value in monetary terms of all of a company’s outstanding shares. Market capitalization is calculated by multiplying a company's shares outstanding by the current market price of one share. Face Book’s has a current market capitalization 142.99 billion USD.  Again putting this into perspective the British engineering aerospace company Rolls Royce has a current market cap of 32.26 USD billion. The US automobile company, Ford has a current market capitalization of 63.62 billion USD.   
Now ask yourself this question, is Facebook really worth more than four times Rolls Royce and more than twice Ford.  
Facebook may have a billion users, but this glorified bulletin board is finding it challenging to turn users into a revenue stream. Indeed, some users are turning away from Facebook in the belief that their privacy is being violated.  Also the preposterous amount of money that Facebook paid for Whatsapp, the mobile messaging service, 19 billion USD, defies business logic. How many users have switched to rival free messaging services when Whatsapp  tried to charge its customers, who now have free alternatives, such as Line and Tango, just to name a few?

What we are seeing is more than irrational exuberance this time, indeed it seems more like investor insanity!  Perhaps it is fitting that Mr. Zuckerberg now has a wax model in Madame Tussauds  because  when his investors eventually hold a candle to re-examine his business model they may find their wealth vanishing,  just like the melted wax of  Mr. Zuckerbeg’s  model in Madame Tussauds. 

Darren Winters 


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