"Tech Bubble." The very phrase sparks emotional responses. Veterans of the dot-com bubble in 2000 are issuing warnings and drawing disturbing parallels with 2015. They are clashing with a new young group of entrepreneurs and venture capitalists who are unconcerned with the past. Anyone wishing to supplement either point of view can find plenty of material online to bolster his or her argument.
What do we think? We're going to take the side opposite Mark Cuban — always a dangerous proposition — and contend that while there are some warning signs, we are not in bubble territory just yet. Let's contrast a few market aspects of 2000 and 2015.
- Initial Public Offerings (IPOs) – The dot-com bubble featured unbridled optimism, with companies rushing to issue IPOs before having any revenue — or in some cases, a reasonable business plan. The focus was less on cash and profitability and more on exposure and promise. .
The average time from the start of a company to the IPO was less than four years in 2000; today, it's closer to eight years. Companies are waiting longer to launch IPOs, and those IPOs are larger once they do launch. By the time of launch in 2015, business plans are set, revenue is coming in, and a plan for profitability is in place. .
Venture capital (VC) fundraising is still well below the levels of 2000, yet they are on a fairly sharp rise — and more of the funding is going into late-stage funding rounds. This may be part of the reason that IPOs are being delayed and are larger when they do arrive. VC funding is bridging the gap. That's not necessarily bad, but the late-stage VC increase is being outpaced by late-stage company valuations.
In essence, VC and private funding have propelled tech companies to high values, but there is nowhere near the total abandonment of fundamentals that we saw in 2000. However, overvaluation is going to lead to eventual earnings and profit pressures that many of the tech companies are going to have difficulty in meeting.
- Overvaluation – The NASDAQ Composite Index recently topped its peak value of the 2000 bubble. That milestone, combined with some inflated price/earnings (P/E) ratios, has some analysts proclaiming a new bubble. Steve Tobak of Fox News reported that of the 50 technology stocks he follows, eight of them have P/E ratios over 100 and two are over 1,000.
However, inflated P/E ratios are not nearly as rampant across the board as they were in 2000. Casey Research ran a series of persuasive articles on the absence of a true tech bubble, punctuated by a graph from S&P Capital IQ plotting both prices and normalized P/Normalized EPS (earnings per share) ratios from 1994 to 2014. The two curves tracked relatively closely throughout the meteoric rise and fall of the dot-com bubble. Over the last thirteen years, these curves have diverged, with stock prices hitting peak levels while P/EPS ratios are rising much more slowly. Profits simply don’t cost as much as they did during the bubble.
Casey Research concludes that the last few years of the NASDAQ rise is due in large part to unrealized earnings expectations, and that expansion of the P/E multiple is responsible for more than 80% of the previous year's gains. It's not so much a bubble as it is a market in need of pricing adjustment — and so far in 2015, the market has continually dragged the NASDAQ back down below 5,000 (4,939 as of this writing). The forces of correction are already at work.
- Federal Reserve Policy – While the NASDAQ has reached new heights, keep in mind that the S&P 500 and the Dow are also setting records. The Fed's economic stimulus policy and artificially low interest rates have made stocks across the board the only viable alternative for decent returns on investment. If there is a bubble forming, one could argue that it’s a different type of bubble, with at least some basis in monetary policy.
We agree with some of the warning signs, but the amount of publicized discussion about a tech bubble leads us to believe that bubble-driving blind optimism just isn’t there. There is still enough healthy skepticism scattered throughout the market, even among VC groups.
However, we do agree that the trends suggest a correction is in order for the NASDAQ. Without some correction over the course of the year, we might be persuaded to join the crowd proclaiming a new tech bubble.