Tech Stocks Are Falling, but Don’t Buy Just Yet

Technology stocks have climbed over the last year, but I'm seeing articles in the media purporting that prices are approaching an iceberg. I think they may be right.

This nervousness may have been created by the Fed's announcement in December that it plans to scale back the economic stimulus. The Federal Reserve Bank threw the stock market a life boat in 2008 by funneling money into the economy via the bond market. As Tech Strategist Fred Hickey put it, "the only thing holding this balloon up is the Fed blowing air into it."

Optimists expect a rebound saying that technology has been the life jacket of a sinking economy, while pessimists, including economics expert Robert Shiller, believe current prices harken a tech-stock bubble.

How does the data look?
Promising: three tech giants, Facebook (NASDAQ: FB), Twitter (NYSE: TWTR), and Netflix (NASDAQ: NFLX) achieved good results in the fourth quarter of 2013.

Company 

Fourth quarter revenue growth

Four quarter earnings growth

Facebook

63%

20%

Twitter

116%

18%

Netflix

26%

19%

Source: Zacks.com.

Despite their success, these three giants faced a steep price decline for the week ending April 11, landing 20% to 45% below their recent highs. While still posting spectacular growth numbers, Facebook, Twitter, and Netflix have still been somewhat of a disappointment.

The reason: high valuations.

Facebook
Recent decisions by Facebook have left some aghast at the reckless confidence of some players in the tech sector. In the past two months, Facebook agreed to pay $19 billion for WhatsApp, a mobile messaging service that had little revenue and $2 billion for Oculus, a virtual realty device maker that has not even released its first product.

Facebook financed these ventures with its own stock, and saw its shares drop 20% from the high. Facebook's acquisition of WhatsApp did not receive a warm reception on Wall Street, as shares slumped 4.8% to $64.80 in after-hours trading following the deal.

Twitter
Twitter has also flashed warning signs since it went public last November and priced its IPO at $26 per share. Initially Twitter did well; by the end of the 2013, Twitter's stock doubled to its peak of $74.73, and it was valued at $50 billion . However, Twitter hasn't yet earned a profit in its eight-year existence.

Twitter is investing in growth, but I was hoping the company would be closer to breaking even. Twitter reported a net loss of $69 million for the first half of 2013 and has continued the trend. Twitter's considerable spending on research and development, which claimed 44% of its revenue in 2013, $112 million, has kept profits out of reach.

Down the line, investors should expect to see an enhanced suite of advertiser-friendly products, stronger data analysis tools, and increased customer data for advertisers. However, spending nearly half of revenue on R&D sounds like a business in search of a blockbuster product.

Netflix
Netflix was also among the tech stocks that made big moves April 11, falling 2.4%. Like Facebook, Netflix was among the highfliers, with its stock peaking at $458 at the beginning of March.

The increasing American consumption of Netflix led some investors to remain hopeful of its growth. Netflix CEO Reed Hastings responded to the excitement around the stock by saying he believes Netflix's stock is artificially high because of the sense of momentum by investors.

Netflix shares closed the week 30% below their recent peak.. One possibility: Netflix's net profit margin is just 1.2%, with a return on equity of merely 5.3%.

With an extremely low margin, the company has little room for error – that's tough considering that Netflix competes in a capital-intensive media business against the likes of Hulu and Amazon.com.

Final thoughts
In short, although it may be tempting to purchase Twitter and similar stocks while they are dipping, it might be wise to wait.

Naysayers may see caution at this early stage as overreaction, but wise investors should consider that prices could drop further. Investors who see the signs and hold out to buy at lower prices will find themselves with two things -- a greater margin of safety and greater investment profits.

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