With the tech heavy NASDAQ index running up somewhat 40% just in the last year. Many experts on Wall St. are warning that this sector bubble may burst. After the lessons learnt from the Dot.com boom and bust in 2001. here’s your breakdown of the tech sector boom so far and exactly why it may eventually bust.
The Dot.Com boom and bust – lessons learnt
Let’s start this blog by diving into the history books of the tech sector thus far. Particularly a close look at the dot.com boom and bust that occurred in the early 2000s. As host Andrew Baxter mentions, this was a time where a lot of people made a lot of money on companies that had ANY relation whatsoever to a dot.com business.
Basically, their share prices went bananas. Fast forward to March 2001 where company valuations where so far stretched from reality to which we saw a major burst of the bubble and many investors give back a large portion of their bank through the early tech crash.
When valuations become stretched bubbles start to form
The next important notion to understand is how in fact ‘bubbles’ are formed from the start. Quite frankly, the majority of these tech stocks (especially the new up and coming businesses) don’t have any actual earnings as yet – meaning traditional forms of company valuation like the P/E Ratio, for example, don’t work because their earnings are infinite.
When investors are buying a stock for what it could potentially earn in the future, valuations can become so far stretched and often a ‘bubble’ is formed. Combine this with positive market sentiment and an innovative business model and Wah Lah – you have an overvalued tech sector operating in a bubble.
The three types of tech companies
Like any sector in the stock market, there are always various calibres of businesses which perform better or worse than the others for various reasons. With the tech sector, there are specifically three levels of hierarchy – the monopolies, the market leaders and then everyone else. The monopolies include businesses like Amazon on Facebook who has managed to sustain significant first movers’ advantage and remain at the upper echelon of their niche.
These are the businesses, as Andrew Baxter exclaims, ‘that have focused on growth rather than profit’. Amazon for example, now has a P/E ratio 126x its earnings that’s tracking for 20-30% YOY growth – a tribute to their CEO Jeff Bezos for creating an incredibly cultured company DNA and customer service focused ethos. The next tier down on the list is the market leaders – businesses like Uber, Netflix and Zoom. These companies are at the vanguard of what they do, providing unique services and simply have set out to ‘own’ the space in consumers’ minds.
Think about it – what’s the first word that comes to your mind when you think of streaming? If you’re like most people on planet earth, that word was probably Netflix. The same goes for rideshare and Uber as another example. These businesses have all developed innovative business models that stand out from the crowd. And lastly, the third tier of these tech companies is basically everyone else. Those who are getting to the game late despite feeling as though there is enough market share to go around. Whether there is or not, is the million-dollar question.
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How to trade the tech boom, bust or bubble
Just like the dot.com boom and bust in 2001, there has been a lot of money made thus far from trading tech stocks on the NASDAQ this year. Given some of these stocks have ran so hard in recent months .
The third tier, Johnny Come Late businesses are ones that could potentially see a further surge given the sector continues to rally as it is. As always, investing in this growth-focused momentum tech stocks. Can be a great idea given the future relevancy of these businesses is ever increasing.
One important thing to note – trading tech stocks can be a wild ride. And thus having prudent risk management in place to protect yourself in the event of another dot.com bust is crucial. Whether or not this is a bubble, a boom or a bust. Reach out to Andrew’s team at Australian Investment Education to learn how you might be able to collect some cash trading these great businesses.