How to Profit from the Next Investing Bubble

"Bubble Alert! LinkedIn IPO Doubles" -- Wall Street Journal

"Internet Bubble Brings Back Dubious Metrics" -- Reuters

"LinkedIn's Sizzling Debut: Memories of Another Bubble" -- The Economic Times

"Social Networks Bubble Away" -- Financial Times

If there's one word that gets investors' attention, arousing not only fear of catastrophic losses, but also overwhelming greed, it's "bubble." Over countless boom and bust cycles, investors have learned that bubbles will form in any market, from the Dutch tulip craze to the dot-com crash to our recent housing fiasco.

So when LinkedIn (NYSE: LNKD  ) went public last week, closing at an astronomical 37 times last year's sales at the end of its first day of trading, fears of a new bubble on the rise spread throughout the market. The leery eye most investors are casting toward the next wave of technology darlings is understandable; this ain't the first Internet-bubble rodeo. Only a decade ago, the dot-com bubble burst, and the Nasdaq plunged by 78% in two and a half short years.

Memories of bubbles past
Worse yet, back in 2000 the bubble was unavoidable. The false promise of a new golden age of technology that would make workers vastly more productive, ushering in a sustainable economic boom, propelled all stocks forward. Coca-Cola, that venerable old consumer staple, traded for 60 times normalized earnings. 60 times earnings!

If social tech companies and other Internet darlings are once again partying like it's March 2000, does that mean that it's too late to find big gains in tech stocks without paying wildly speculative prices on the next too-good-to-be-true growth story?

Of course not!
In the dot-com heyday, market caps at Microsoft (Nasdaq: MSFT  ) and Cisco (Nasdaq: CSCO  ) both broke the $500 billion barrier. But today's most well-known social web darlings -- Facebook, Twitter, Zynga, Groupon, and LinkedIn -- command a combined market value of around $110 billion at today's trading levels. 

Assuming the four other companies joined LinkedIn, went public, and all saw their share prices double, they'd still only be worth about $210 billion in total. That might form an overheated group, but it would only constitute 10% of the Information Technology segment of the S&P 500. Dot-com era Microsoft and Cisco alone would equal 50% of today's entire S&P technology segment!

Back in 2000, the emergence of a transcendent new technology, the Internet, boosted valuations on nearly all technology leaders. Today's transcendent technology -- new forms of social media and cloud computing -- are pressuring the values of an already established group of technology leaders. Thus, while companies like Facebook and Twitter soak up media attention, their relative price gains pale in comparison to the stock losses seen at leading companies like Microsoft, Hewlett-Packard, and Cisco.

This presents a huge opportunity for us.

See, while most technology companies continue growing earnings, their market values are growing much more slowly, if not shrinking outright. To see this idea in action, look at how much the 10 largest technology companies from 2008 have seen their P/E ratios compress.

Company

2008 P/E

2011 P/E

P/E Compression

Microsoft 17.2 10 (42%)
AT&T 19.7 9.3 (53%)
Google 40.6 20.6 (49%)
International Business Machines (NYSE: IBM  ) 16.5 14.3 (13%)
Apple (Nasdaq: AAPL  ) 37.8 16.2 (57%)
Cisco 20.6 12.8 (38%)
Intel (Nasdaq: INTC  ) 21.6 10.9 (50%)
Oracle (Nasdaq: ORCL  ) 23.1 23.3 1%
Hewlett-Packard 15.9 10.3 (35%)
Verizon 20.0 29.8 49%

Source: CapitalIQ, a division of Standard & Poor's. Reflective of May 19, 2008 and May 13, 2011 closing prices.

The out-of-this world selling prices seen in social media stocks aren't propelling other tech stocks forward. Instead, social media companies are living in their own separate "bubble," while the largest technology companies see their P/E ratios descend to the cusp of single digits.

That's where opportunity lies
The fears surrounding the largest technology companies are often mutually exclusive, yet a wide swatch of these companies have seen their stocks beaten down. Consider that Microsoft, Intel, and Hewlett-Packard all trade for only around 10 times earnings, largely on fears that smartphones and tablets will sap their growth over the next decade and eliminate PCs. That mobile revolution could prove well-founded; smartphone makers sold more than 100 million smartphones handsets in the first quarter, and growth rates remain astounding.

However, at the same time, the two leading companies of the mobile revolution, Apple and Google, have seen their P/E ratios slashed in half over the past three years. In the March quarter, Apple grew net income 92% versus the previous year, yet it only trades for about 16 times earnings! Could you imagine Microsoft trading for 16 times earnings when its earnings were growing 92%? In the entirety of the dot-com bubble, Microsoft only posted earnings growth that exceeded 92% once. IBM, a company now delivering on a plan to double earnings per share between 2009 and 2015, still can be had for 14 times earnings.

Therein lies the key to profiting from a social media bubble. While blazing-hot IPOs will garner much of the media attention over the next year, they're only one niche of the overall technology space. Unlike 2000, when the bubble spread far and wide, the stocks of today's actual tech leaders are stuck in the mud. If companies like Apple and IBM keep growing profits at outsized rates, the market can't continue to ignore them in favor of new hot IPO -- not for long, anyway. Take advantage of the real investing opportunity in technology while it lasts.

Looking for some investing ideas in the fast-growing mobile space? The Motley Fool compiled a report of five stocks that the Fool owns and that you should own, too. One of the stocks was a recommendation I made, a mobile leader that has already gone on to gain more than 45% since last summer. Best of all, it still has room to run. To get the report, just click here – it's free!

The Motley Fool owns shares of International Business Machines, Microsoft, Apple, Google, Oracle, and Coca-Cola. The Fool has created a bull call spread position on Cisco Systems, and owns shares of and has bought calls on Intel. Motley Fool newsletter services have recommended buying shares of Google, AT&T, Microsoft, Intel, Coca-Cola, Cisco Systems, and Apple, and recommended creating diagonal call positions in Microsoft and Intel, and a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Eric Bleeker owns shares of Cisco. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (11) | Recommend This Article (61)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 24, 2011, at 5:19 PM, EquityBull wrote:

    Apple is likely to hit at least $30/share in '12. Slap a conservative discount to its growth last quarter which was 90% and instead say 30%. This gives you 30 times $30/share or $900/share target. Tack on another $100 billion in cold hard cash which is $100/share and you get $1000/share target.

    Even if you believe apple growth will plummet from 90% to 20% (unlikely but lets' play conservative) then you still get $30 x 20x or $600/share plus another $100 cash yielding a $700 target or 100% upside from here. Again this is the conservative valuation. As the author noted the market will only ignore the earnings thumpings for so long. Once the stock starts moving all the funds will pile on fast and the ride to $1000 will be swift.

    Should apple split 5 for 1 or 10 for 1 the ride will be much faster I believe and exceed the fair multiple with the stock hitting north of $2000/share split adjusted

  • Report this Comment On May 24, 2011, at 5:48 PM, mountain8 wrote:

    really want to believe this. Is there anyone out there who would like to add or subtract from EquityBull's evaluation?

    the $30/share is what... revenue per share or what?

  • Report this Comment On May 24, 2011, at 7:27 PM, TMFBreakerRob wrote:

    @mountain8, $30/share is EquityBull's thought on 2012 EPS. It's possible and is a frequently discussed number for that year on various chat boards.

    In my opinion (I speak only for myself), I think we'll be darn fortunate to see a PE of 20, I prefer to just consider a PE of 15 or 16 because that's what the market is willing to pay for a fast growing giga-cap apparently. That can still get you a potential price of $500 or more with $30 EPS....but I wouldn't bet my life on it. Instead, I only choose to invest in it. ;) I've got about 5% of my portfolio in AAPL and glad of it.

    Oh....I wouldn't count on a stock split either. Apple has given no indication that they are interested in doing so and I wouldn't suggest basing an investment on that eventuality.

    If all the wishes and hopes come true and Apple has a higher share price than $500 in 2012, then its gravy. But don't count on gravy....we could also see that the price goes no where in that time...the market sometimes does odd things.

  • Report this Comment On May 24, 2011, at 8:44 PM, DBrown7 wrote:

    If earnings reach $30/sh for the year ending 9/12 and the stock is still trading where it is today, that would make AAPL selling for 11x trailing earnings. It's not impossible, but would seem highly unlikely absent a general market collapse. At that point the stock would also likely trade at a single digit

    P/FCF.

    By the way, I would not be at all surprised if AAPL earned more than $30/sh. for fiscal year 2012.

  • Report this Comment On May 25, 2011, at 10:36 AM, mikecart1 wrote:

    "That's where opportunity lies"? All the companies mentioned are dead. Microsoft is dead. It will never see $500 billion market cap ever again as long as Bill Gates is alive. Same with the other companies. The 2000 bubble was once in a lifetime. I wish people would stop talking about the past and start talking about the future. Jesus Christ!

  • Report this Comment On May 25, 2011, at 1:38 PM, sailrmac wrote:

    P/E multiples are based on expected future growth in earnings not past growth in earnings. If AAPL's earnings are $30 a share in 2012, but the market thinks those earnings are going to drop then the P/E is likely to be in single digits.

    Don't think this can happen? It has before, to this very same company. It's hot new product back then was the computer and GUI interface. They had the best product on the market in a very high growth industry. Then that space was taken over and dominated by competitors and the creative genius left.

    Just because a company has grown earnings at 30%+ doesn't mean it's going to continue to do so. As a matter of fact the vast majoirty of companies which post 30%+ earnings growth do not continue to do so. So it would be very surprising if AAPL was able to continue to grow earnings over the next 5 years anything like it has the last 5. That kind of growth over that period of time is just a very rare thing.

  • Report this Comment On May 25, 2011, at 4:17 PM, HessenFool wrote:

    How come every time I try to read any of the free reports I just get redirected to the fool homepage????

  • Report this Comment On May 25, 2011, at 4:48 PM, TMFRhino wrote:

    Thanks for commenting everyone.

    HessenFool,

    I'm not sure why that is. I just clicked the link and it took me to the report.

    Mikecart1,

    Microsoft hitting $500 billion was never a point of the article. The two companies I highlighted as good investment candidates were IBM and Apple.

    Sailrmac,

    Totally fair that Apple's growth could slow - 92% is clearly not sustainable. However, they've been growing well for awhile and while smartphones are rapidly increasing in penetration, they still have a large addressable market to reach. Also, tablets are still a new technology with room for growth. Apple doesn't need 30%+ growth over the next five year. Let's say it moved down to a more modest 15% (and the fact that next year should be well above this rate,makes attaining a compounded rate of that height much easier), that would leave cash flows close to $50 billion a year. I do think some people do get ahead of themselves looking at Apple (very ahead...), but even at far more modest growth rates, the company still looks attractively priced in my opinion.

    -Eric (FWIW, I don't own Apple, Microsoft, IBM, or any company mentioned above)

  • Report this Comment On May 26, 2011, at 12:05 PM, garrettandy wrote:

    so what do you guys think of the forthcoming zynga floation - invest or avoid? they have a lot of big players involved

  • Report this Comment On May 27, 2011, at 12:21 PM, tornado63 wrote:

    How come every time I try to read any of the free reports I just get redirected to the fool homepage????

    The same always!!!!!!!!!!!!1

  • Report this Comment On May 27, 2011, at 12:45 PM, TMFDanielSparks wrote:

    Apple is definitely undervalued. I think that 30% IS a conservative growth rate for the next 12 months--definitely.

    Apple simply has too many things going for it to slow down any more than a 30% growth rate over the next 12 months.

    Apple makes up almost my entire portfolio. Why would I put money elsewhere when Apple is at a rock bottom valuation? There is no downside left. It's economic moat is as wide as they come. It's a cash producing machine.

    Think I'm crazy for putting nearly my entire portfolio in Apple stock? Come talk with me in 5 years and you'll wish you did the same.

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