The return of the bubble

I am not going to question whether we are witnessing another ‘tech bubble’ or not. Because, we certainly are and the recent spate of valuations merely proves this fact. LinkedIn has gone public today morning (May 21’ 11) and its share price shot up by a massive 109%, from $45 to $94.25. What do the calculations tell us – a P/E ratio is 554. Does it command such humungous premium? I seriously doubt it.

There is certainly a difference between the tech bubble of the 1990’s and the one we are witnessing today. Today, the companies have successfully proved their business models and are not just mere start-ups. Let us consider the popular examples of Facebook, Twitter, Groupon (www.groupon.com), Zynga (www.zynga.com), whose premium valuations are under the scanner now. Each one of them has a successful business model for the last couple of years. They have got a subscriber base in hundreds of millions. They have reported positive returns of millions of dollars, in the last year. But the companies in the 90s were either start-ups or in their initial phases, with no proven track record. Some of them were bought out by larger players, and the larger ones absorbed huge losses later – e.g., Yahoo’s purchase of Geocities. And many of them died of bankruptcy.

But, do the companies of contemporary times command these huge premiums? I feel that rather the companies demanding such premiums, it’s the investors who are queuing up madly for such companies. And the interesting question is why these ‘tech companies’? A few reasons are – Firstly, lack of choice. The US is still reeling under the tragedy of the recession and with lacklustre growth. Even though the results of certain sectors like autos, retail are looking optimistic, they are not guaranteed. And the housing sector is yet to rebound and could take its own sweet time to show any signals of coming back to life. Secondly, it is the valuations of these tech companies by some financial majors, without any supporting fundamentals. And it is the classic cycle which starts all over again. HNIs start to buy these stocks privately, followed by hedge funds (or could be vice-versa) and finally the company goes public with unimaginable valuations, only at the loss of the retail investor. Also called the ‘Bandwagon effect ‘by management graduates like me!

And this time I wish a healthy correction happens soon and bring back to meaningful and deserving valuations, rather than waiting for more tech companies to join the bandwagon, only to burst the bubble finally.