While we wait for the FOMC statement this afternoon, which may bring some volatility to the market as analyst try to read the tea leaves, it is the tech sector that is bringing some volatility to the market. Are we in a semi-tech bubble?
I was a market maker during the dot.com boom and living in San Francisco, the euphoria was contagious and if a company had a “.com” in their name it was a sure fire bet that IPO was going to rocket. It was blind faith that disregarded fundamental business and reminds me of the recent housing bubble.
Today we are not in that same euphoria, but there are some companies in the tech sector that are priced significant multiples to growth rates. What is different this time is that the global growth for emerging internet service companies may warrant huge multiples. With billions of people around the world participating, the market foot print is massive.
Just think about the numbers for a second. In the US there are approximately 300 million people; Twitter has over 300 million active users. That is an amazing number of users when you compare it that way. Twitter has MORE users than the U.S. population.
That alone shows how fast and expansive the internet service business can be and early high multiple valuations could very well be warranted.
However there is a shifting period of growth rate based on what is sometimes referred to as “maximum penetration” and eventually “market saturation”. This is the time in which the adoption rate that reflects double digit year-over-year growth has reached the vast majority of potential users. Remember there are a finite of possible users.
The company moves into a new phase of growth which is based on gaining users through competition among existing users and new or existing competitors. Additionally growth rates is based on population growth and opening up new markets. There certainly can be jolts of growth if a new market opens and you see a mad rush for adoption, but these growth rates are not sustainable.
If you look at highly saturated markets, like cell phone data services and cable services, the growth in these companies are always measured by a combination of a drop in subscribers vs. new subscribers as the behemoth’s try to steal each other’s market share.
It is not to say that once a company hit’s maximum penetration and market saturation that they are unprofitable or that growth is over, however expecting to see huge double digit growth from new users is not likely.
Recently earnings in some tech companies have brought forth some volatility to the market as there is concern about growth rates.
Courtesy of wiki
If we look at Twitter’s earnings they beat estimates and the numbers were looking good. In fact when the earnings were released the stock was initially up sharply, so what happened? The earnings call with the interim-CEO brought forth concerns about their growth rate. The company was not happy about their growth rate and even went as far as to say they are not happy with their own ability to educate people WHY to use twitter. The stock has dropped sharply after the earnings call, not based on the actual earnings but the CEO not being happy with future growth.
My opinion about Twitter is that services like Twitter are good business models if one can figure out how to monetize the service. Twitter has with advertising and seems to be doing very well. That is not to say a Twitter competitor will come along and do it better.
My conclusion about the conference call is simply that either the interim-CEO doesn’t have a good handle on their potential “maximum penetration” growth rate curve and is focused too much on their ability to market/educate. Everyone knows what Twitter is, whether you use it or not. So it is not a marketing problem. I don’t know how much education you need to use the product. Could it be made better or improved, certainly – all companies improve their service over time and Twitter plans on rolling out new product initiatives. It also seems that analyst had a far better handle on growth rate of Twitter and the maximum penetration growth curve, since they had already lowered the growth rate.
The conference call to me made little sense, unless they wanted to set a negative tone for their company. Perhaps it will be a target acquisition now at a lower price. Who knows – it could be just an interim-CEO gaff or they are operating in a bubble and believe that growth should always be double digits. I remember that euphoria in the old dot.com day and when you are in the bubble it is hard to be objective.
Courtesy of wiki
Yelp’s story was similar to Twitter’s; at least the CEO didn’t also rain on the parade during the conference call. The analyst also has already lowered growth expectations in an already saturated market, which is to be expected. The top line revenue rose 50% last quarter, but lost money on the bottom line.
I always like revenue growth, regardless of profits because it is showing a company growing. However, I think these once booming tech companies trading on rather large multiple’s (based on growth) are facing some reality that there is only a finite amount of users and eventually your company has reached maximum penetration and market saturation, in which future growth is about winning consumers from competitors, finding new untapped markets, or create a new vertical revenue source.
I certainly do NOT think we are in a tech bubble; we are just getting a dose of reality about multiple valuations vs. real growth rates.
For the record I do not have positions in either Yelp or Twitter.
Support & Resistance
INDU 17,500 – 17,800
The market could see some chop from earnings, but what it is really waiting for is the FOMC statement and an inclining about a future change in monetary policy (rate hikes). I would think the index would stay in the 17,500 to 17,800 range with some possibly heavy intra-day volatility.
This is a pivotal area for this highly volatile tech heavy index. A couple of big names I mentioned today have come under pressure which could spook the tech sector; on the other hand revenue doesn’t look all that bad. We could visit 4500 in a pull-back if concern is elevated or see a solid move up if the FOMC statement raises broad confidence and lowers fear of rate hikes.
The market wants to rally and is looking to the FOMC statement for some hope that the ZIRP policy is here to stay a little longer. The index did see buyers step back in at the 2070 level and I think on any pull back we could see support again in the 2080 range.
It looks like the Russell is basing on a double dip ready to take off. Fear about rate hikes has certainly seen an exit as measured by this broad index. However, if concerns about hikes are lowered we could see this index take off and get back to 1240 as early as today.
Yellen certainly doesn’t want to spook the market and so far economic data headlines, while looking good, are really not all that rosy. The U.S. maybe the best of the rest of the West, which is not saying much. The problem is the huge money supply and the velocity stall, coupled with ZERO rates. There also remains a possibility of QE4, while slim.
Parts of the private sector are doing very well and the stock market is higher, but we can’t mistake the stock market and/or market sectors profiting as a strong economy. Correlation is not proof of causation – which is a common mistake that many make.
So I am suspecting a rather mellow and mostly unchanged FOMC statement, neither hinting of a rate hike nor keeping rates the same. That of course will not change those that wish to read something into any minute changes as if it is certainty. It will be perception and not certainty that will bring volatility to the market this afternoon.