How to turn a billion into a thousand – the Web 2.0 way..

By Filipe R. Costa

When Alan Greenspan was asked about the apparently unstoppable rise in equities in the 1990s he couldn’t find a traditional metric to define it. He resorted to his now famous comment about “irrational exuberance”.

At the time, investors were irrationally buying anything at any price, just following the crowd. At the same time analysts were inventing all sorts of clever methods to explain why that time was different and established red flags could be ignored. Price-to-earnings, price-to-cash flows, price-to-sales were apparently all too conservative as means of valuing dotcom potential. If you had a website, you could be almost guaranteed your stock would rise during those volatile and heady days. 

Of course, it all ended badly and eventually the market remembered that actually what really matters is making genuine profits, not chasing pipe dreams. However, the market’s memory isn’t permanent and we are seeing something of a repeat of those days as the likes of Facebook, LinkedIn and Twitter all go on wild rips.

Thinking back to the 1990s and companies like Netscape and Altavista were going to change the world. They apparently had boundless potential. Then came Yahoo and Internet Explorer. Now we have Facebook and the like. I am not saying that Facebook will necessarily disappear but the point is that the Internet has changed at such a furious pace over the last 15 years there is no reason to think it won’t continue to change as greatly over the next 15 years.

As such, investors ignore P/E ratios of tech stocks at their peril. It is all well and good projecting growth rates over a decade, but this presupposes that the business will still be the dominant force in that time. Facebook is trading 119x times above its earnings, while LinkedIn is trading 993x above its tiny profits. By looking at their market values and number of active users, I estimate that these companies are valuing each user at around $100:

So what is driving these irrational stock valuations?

Well it is the easy money policy of the Federal Reserve, of course!

Endless money pumping is creating a second bout of irrational exuberance. A recent example of this came in the SnapChat app, available on Android and iOS subsystems. This messaging system has an active user base of around 30 million, but generates zero revenue. Yet this didn’t stop Facebook offering $3billion for it!!!!

The worst part of this story was that the owners declined this offer, as they thought the company was worth more! That’s pure madness. I hope for their sake they don’t end up like the founders of Digg, who declined a hundred million offer, only to end up selling for a few thousand in the end.

Market top anyone?