By Yale Bock
NEW YORK (AdviceIQ) -- This year's choppy stock market makes some investors leery, but a good rule of thumb is to invest in the industries of the future, namely tech and tech-related companies. But which ones and which specific companies? And what should you avoid?
1. Beware of over-valued tech initial public offerings. When new companies in the digital arena go public, their valuations are too often too high to sustain. That leads to price plunges later, burning early investors. The problem is chronic, and shows no signs of abating. Look at possible upcoming IPOs.
Pinterest, whose users share images and videos, is supposedly worth $5 billion. Airbnb, which allows travelers to book rooms (usually in private homes), carries a cool $10 billion valuation. Car service provider Uber, $3.8 billion. Based on a Wall Street Journal report, there are at least 30 startups all over the world that venture capital firms value at more than $1 billion.
Many of these companies are very good examples of why so many investors are skeptical of the stock market. At the behest of the venture firms, investment bankers take these fledgling companies public at levels where the only way early stock buyers can do well is if the companies double, triple or quintuple their revenues and user bases.
Consequently, the depressingly familiar result is what happened with Twitter (TWTR), Facebook (FB), Yelp (YELP) and plenty of other high-tech darlings. They go public at extended prices, the public unfortunately buys them and the stock plummets 20% to 50%. If the company has a good business plan and executes, the stock recovers eventually, which is what happened (and then some) at Facebook and Yelp. Twitter, though, still changes hands at 15% less than its IPO first-day high last year.
Still, the underlying issue is the VC firms help create the problem with their excessive valuations at follow-up financing rounds.
2. Merger mania will continue, offering nice premiums for investors. After a trough in 2009, deals worldwide edged up every year. Through April, merger and acquisition volume held steady. The biggest of all lately, the $120 billion Pfizer (PFE) bid to take over Britain's reluctant AstraZeneca, got called off, but under UK law Pfizer could try again after six months. Nevertheless, other large combinations are pending, such as the $40 billion attempt of telecom giant AT&T (T) to buy satellite-TV provider DirectTV (DTV). Federal regulators have to OK the deal, which may take months to close. The estimate is that the AT&T offer is worth $95 per DirectTV share, a roughly $12 premium over its $83.66 current price. (Full disclosure: My firm owns both stocks.)
For several reasons, I suspect the urge to merge will be in full swing for quite some time: cheap financing readily available, profits at an all-time high, managements under pressure from boards and activists to improve returns, grow their firms or both, and an investment community looking for strong performance wherever they can find it.
3. Don't write off legacy tech icons. Personal computer maker Hewlett-Packard (HPQ), which launched Silicon Valley, has suffered from ill-advised acquisitions and a slowing PC market. HP is always an interesting group, as its collection of businesses is a good proxy for the broad technology industry. With enterprise, printing, software and services and hardware (printers, computers and servers) divisions, its management has a lot to digest.
In this year's first quarter, revenue contracted by 1%, marking the 11th such consecutive decrease. Nevertheless, earnings per share advanced by 1%, which shows management has a good grip on the business.
The company is cutting 16,000 jobs and trying to adapt to the ever-changing winds in the various markets they serve. Its chief, Meg Whitman, is a seasoned executive who is a good leader and is trying to transition the company in the search for growth.
When you have revenues of nearly $100 billion, the hunt is harder to execute than to talk about or plan for. Technology is a very difficult area, as the competition is brutal. No wonder Warren Buffett stays away. But others, such as Mark Andreesen of the venture capital firm Andreesen-Horowitz, think there will be even greater opportunity. He is a member of the HP board and says his commitment to the company "triggers my stubborn gene." (Our firm owns HP for clients.)
The market seems to sense a decent future for HP, whose stock since late 2012 has almost tripled. Meanwhile, it pleases investors with ongoing dividend increases and share buybacks. Beyond that, the stock is cheap, with a price/earnings ratio of just 12.3. That's a good value.
-- By Yale Bock, CFA, owner and operator of YH&C Investments in Las Vegas. YH&C Investments, Yale Bock, his family and clients own shares in the companies mentioned. Past performance is no guarantee of future results. Investing principal in the capital markets is not guaranteed and there is the risk of losing money. The CFA charter in no way guarantees investment results which will be superior to an index.
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