Think this headline is sensational? Yeah I’d agree it’s a little over the top to suggest tech workers get their resumes updated, but I wanted to make a point about something being overlooked in the tech industry by most Wall Street analysts today: earnings. For the most part, they aren’t there. I’m using data from Yahoo Finance to look at various large tech companies trading on public stock exchanges right now and looking at their earnings data over the past 12 months. All data is the latest available as of 6/30/2015
|Company||Ticker Symbol||P/E Ratio||Loss as % of Mkt Value (past 12mo)||Mkt Value (in billions)|
Couple things pop out to me here, HOLY CRAP! LinkedIn, Salesforce, Groupon, Twitter, Tesla, and Amazon are all not making money? Should we be terrified? Yes and No. Amazon has some crazy stat like 175 million users visited their site last month and they account for a significant percent of internet traffic. Netflix accounted for more than one third of the bandwidth of the Internet last year. These numbers are mind blowing and are also why investors are willing to pay super high prices for their stock.
Here’s the problem though for the average smart college grad who just went into the tech industry and is on a three to five year vesting schedule for their stock options. You have to ask yourself, are these options really going to be worth much in five years? To get close to the P/E ratio of the broad stock market which is currently around 20, Netflix would have to figure out a way to increase its earnings by almost 9 times! I love me some Netflix when it’s $8/month but what about if it was $72/month? It’s possible that’s what a lot of people pay for cable, but what if there’s a new competitor that wins over a big contract like a Hulu or Amazon that causes people to switch in mass?
People always look backwards when thinking about stocks, and thinking about how much your stock options will be worth is similar. If Twitter went up 800% the last however many days you extrapolate that in your mind. “Holy cow! I’m gonna be a millionaire!” You exclaim. The problem is Twitter is losing money, and lots of it. You might have millions of users and promising new revenue sources but if anything falls off schedule or something new comes along that competes for eyeballs your company has no fundamental valuation.
The only companies that look reasonable to me on this list are Apple, Google, and Microsoft. At least there’s billions of dollars in earnings to go along with their billions of dollars in valuation. For a majority of big name tech companies today, particularly in the social media space, valuations are sky high and some will certainly crash in the next few years. How did we get to the point where people are paying close to tech bubble 2000 levels for some of the hottest companies out there? I think the easy money policy by the Fed has pushed truckloads of money into these stocks.
I was reading this book Barbarians at the Gate: The Fall of RJR Nabisco over the weekend and one of the lines that struck me was when one of the Private Equity barons said that he needed to get 20+% returns on his investors’ money, and how even a fool could get 11% in Treasury bills. That was a completely different era because money actually cost something. The return you needed to get on risky assets was substantial because the risk free rate of return was so high, so because of that obstacle you couldn’t justify super high P/E ratios and high valuations for money losing companies in Silicon Valley. Now, with short term interest rates near zero, there’s not a psychological cost for seeking out risky returns. In other words people aren’t thinking “dang if this Amazon stock goes down in the dumps I’m going to look kinda dumb since I could’ve got 6% in my savings account.”
Because of this distortion in the economy, tech has performed INCREDIBLY well the past eight years. The trillions of dollars of easy money sloshing around the economy have supported the stock market, but in particular they have supported tech valuations. My phone lit up with friends asking me about the Facebook IPO in a way that made me worried the crash was coming then. I was wrong as Facebook as performed very well and anyone who participated in that IPO has made a lot of money. However, it’s hard to judge valuations when they’re already high. If something is at 80 times earnings, why shouldn’t it go to 100 or 150 times earnings? I’m not interested in trying to get in before the peak because of the downside risk of what would happen if the stock went from an 80 multiple to a 30 or 20 times earnings multiple (aka a 70% fall in stock price). The worst part is the price of a stock like Facebook fluctuates violently on something minor like mobile ad revenue ticking up a little or emerging market user demographics improving. It’s not meat and potatoes like the $28 billion Exxon Mobil made last year or the $47.8 billion Apple made last year (as of 6/30/15). When interest rates go higher and there’s a charge for all that money these hot companies are burning the need to get earnings fast will be more important, and the ones that can’t do it will plunge in value.
So if you work in the tech industry at a big name that doesn’t have a solid P/E ratio of 30 or lower, I’d seriously discount the stock options that are pledged to you. When this easy money stops or the economy hits a recession, you could be in for big trouble if you are counting on that money from your options being worth a ton. There’s nothing wrong with having a big percent of your net worth tied up in options, it’s actually a little exciting, but please please please hedge your risk. The S&P 500 is composed of about 20% tech, so if you are investing in your 401k or buying Vanguard index funds you are inadvertently exposing your net worth even more to the tech industry. I’d say you should check out Value Funds if you are going to buy mutual funds or if you want to buy individual stocks, have a solid helping of those meat and potato stocks like McDonald’s, Exxon Mobil, Walmart, JP Morgan, Southern Company, and others with solid earnings histories that are going to do ok in recessions.
The triple net worth whammy is when your job is in SF working at Big Tech, you have a tech heavy stock portfolio, and you own a house in the Bay Area. Every part of your life is heavily exposed to a crash in the tech sector and if that’s the case even a rich person could lose it all and end up broke. I don’t want that for you please at least have a quarter of your net worth in savings and stock of conservative companies not in the tech sector. If your options represent the majority of your net worth then probably all your outside savings should avoid the industry since so much of your assets are tied up in the health of your company.
The best time to work in tech was five years ago. Facebook and Twitter millionaires were being minted all over the place. If you’ve made the decision to join one of these types of companies that’s burning through cash at a high rate, ask for higher levels of cash compensation when you join versus equity if you can negotiate that. If your options are valuable one day you’ll be rich enough but if they aren’t valuable one day you want to have something to show for your time coding away. If you have the opportunity to start your own firm and your options are only partially vested, as long as its a solid number that you’ll get why not go for it? If you have more than $500,000 that’s a lot of money and the life joy out of pursuing a passion is probably worth more to your psychic health and self actualization need than the extra money is.
If you’ve done well in tech, protect yourself and your family by investing a lot in sectors outside tech and having a solid amount of cash on hand, that way your rich if you do well in your job and rich if you don’t. It’s a WIN-WIN BABY!!!