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August 1, 2013

Reviewing Valuations for Large Cap ‘Fallen Angel’ Tech Stocks

by Steven Carroll.

Anyone arguing that the market for large cap technology stocks is efficient should take pause at the sector’s performance over the last 15 years. From the highs of 1999 and early 2000 to the lows of 2003 then back to the 2012 exuberance of social media, the sector has certainly provided market watchers with plenty of fodder. As the tech sector is all about timing – we used StarMine research to review current valuations.

BlackBerry’s uncertain future

If you didn’t own a phone from BlackBerry Ltd. (BBRY.O) (formerly Research in Motion), during the financial crisis, you probably didn’t work in finance. It had a market share of 55% in the first quarter of 2009, according to research firm IDC. Now at less than 3% market share, Blackberry’s fall more than any other reminds us that tech isn’t a place for the casual investor – by the time you’ve identified a trend, it’s ending. BlackBerry reported a loss in the fiscal first quarter ended June 1 and said it expects an operating loss in the second quarter, as well, making meaningful valuations difficult.

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Apple’s heroic valuations

In 2011, it was Apple Inc.’s (AAPL.O) turn to be the darling of the market. It beat estimates quarter after quarter and was rewarded with a valuation that implied 35% compounded annual growth – for a company that was already reporting $108 billion in sales. In 2012, as the price peaked, the valuation still implied a heroic 15% compound EPS growth for the next 10 years. That’s 15% per year for the next 10 years. Often referred to as a Goldilocks valuation, it assumed things would be “just right.” The world doesn’t often work that way for extended periods and unsurprisingly, APPL, like BBRY before it, found that their sustainable competitive advantage wasn’t. If you were particularly bearish, you’d look at the two charts and wonder whether APPL is merely two years behind BBRY. However with a valuation that implies just 0.2% EPS growth for the next 10 years and a track record of successful innovation, perhaps it’s time to take another look. The StarMine Intrinsic Value for AAPL is $550.50 on today’s estimates.

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Overblown valuations

It’s easier to spot stretched valuations several years after the event, but where in the tech sector are we seeing stretched valuations now? Using the StarMine Intrinsic Value model, we take a look at several companies with excellent management and product, but perhaps where hype and over-enthusiasm is taking shape. We’re not saying any of these companies won’t change the world – after all, the forecast that Cisco’s Internet plumbing would be ubiquitous was right – it was simply that all that and more was in the price at around 200x 1999 earnings.

Amazon’s lofty heights

Another name that has lasted since the first tech bubble – Amazon.com Inc. (AMZN.O) certainly makes our list on the basis of massive expectations. Who knows – they may come to pass – but according to StarMine’s Intrinsic Value model, to justify the current price you’d need AMZN earnings to grow at 44.4% every year for the next 10 years. That ranks AMZN in the most expensive 1% for American stocks. Some stocks do execute flawlessly for a decade or more (think of MSFT or GE) but there is no cushion, no margin of safety, as Warren Buffett says. When AMZN disappoints the market on margins or sales, the stock has the potential to correct significantly. On traditional valuation bases, the stock also looks punchy – a forward PE of 136.4 and over 13 times book value. Of course tech watchers will say those types of metrics don’t apply to fast growth tech stocks, but is that just another way of saying … this time it’s different?

Pressure on LinkedIn

LinkedIn Corp. (LNKD.N) is another stock where the business model looks interesting. It’s become a familiar part of any professional’s marketing and career toolbox.

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However, on a forward 12M PE of 103 it seems that success is assumed by the market – and any setback is likely to see a substantial derating. Looking at the StarMine Intrinsic Value model, we see that LNKD would need 38.4% compound growth for the next 10 years to be fairly valued. For the stock to surprise, it’s going to need to earn more than that. To put things in comparison, GOOG’s current price implies 11.5% compound growth – still impressive and double digits – but broadly achievable in line with their market share and continued product expansion.


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