A look back into 2013 to see what's ahead in 2014
Year-end predictions are a fool's game -- especially when it comes to tech stocks -- yet one that many find too irresistible to sit out. If anyone really had a gift for reliable predictions, they'd keep their mouth shut and just make their shrewd investments. It's more of a parlor game, a conversation of the moment, one that most assume will be forgotten in the coming months.
And sure enough, 2013 had its share of events that proved the publicy declared predictions of a year ago wrong. Apple will skewer its bears? No, Apple gained only 5 percent in a great year for tech stocks. Cisco poised for solid gains? Not really, it also lagged the Nasdaq. Facebook will have trouble rallying above its $38 a share offering price? Nope. The drought in tech IPOs will continue through 2013? Guess again.
The best one can do at the end of the year is more like a weather forecast, taking stock of current conditions and considering how they have played out in the past. So before looking forward, I am going to look back at some of the more interesting trends in 2013, and then, assuming there are no surprises, how things are likely to play out next year. I know, those surprises can change everything, but this should do for a New Year's Eve parlor game.
The summer of Facebook. After languishing below its offering price for more than a year, Facebook's stock suddenly began to surge this summer. Before it reported its second-quarter earnings, Facebook's stock was unchanged from the end of 2012. Since those earnings, the stock has risen 108 percent.
The reason: Facebook was successfully monetizing the shift among users from the desktop site to its mobile app. Facebook's mobile revenue became 44 percent of its total revenue in the second quarter of 2013. A year earlier it was virtually nil. By year's end, that figure was well above 50 percent. As a result, Facebook's overall revenue growth went to 60 percent last quarter from 32 percent a year earlier.
Can it last? Hearing Facebook talk about it, the company is likely to see revenue slow to well below its current growth rate. The mobile-revenue growth was sudden – and strong. But next year growth rates are likely to slow. Growth rates are typically measured annually – but a year ago Facebook had little or no mobile revenue to compare. The year-on-year comparisons won't be so easy in 2014.
Along with Facebook, most Web stocks also saw gains, especially those that showed they could make money from the mobile Web. Examples. It wasn't just that investors were pleased to see mobile being monetized, it was also that many funds were moving money out of bonds now that the Federal Reserve was signaling it would soon taper off its generous monetary policies.
The return of the tech IPO. In 2013, 222 companies went public, raising $55 billion, according to Rensaissance Capital. Both figures barely surpassed the previous highs of 2007 and made this the best year for IPOs since 2001. Of those, 45 were technology companies raising $8 billion, and 81 were venture backed (in tech and other industries), raising $10 billion.
Most visible was Twitter's, which raised $2.1 billion in early November. Twitter ended the year 132 percent above its $26 a share offering price. Other, lesser known tech IPOs had strong returns as well: ecommerce site Zulily, up 85 percent from its offering price; Chinese sports-lottery site 500.com, up 189 percent; data-software company Tableau, up 119 percent; ecommerce platform ChannelAdvisor, up 190 percent.
Others, however, performed poorly: network-software maker Cyan is 52 percent below its offering price; while video-ad network Tremor Video is down 48 percent.
2014 may not have a blockbuster IPO like Twitter or Facebook in its pipeline, but there are plenty of companies that could go public: Dropbox, Square, Coupons.com, Jawbone, Box, Zoosk, King.com, Warby Parker, Care.com, Go Pro, Lending Club, and many others. The strong aftermarket of Twitter, Tableau and others may lure some companies whose founders have been adverse to the IPO market for the past decade.
The redemption of turnaround stocks. Among the surprises in 2013 was that some stocks that had been struggling to turn themselves around saw rebounds in their share prices. Beyond Facebook, there was Hewlett Packard rose 101 percent; Yahoo gained 111 percent, Groupon 151 percent. Even Zynga rose 50 percent, beating the Nasdaq Composite's 40 percent rise in 2013.
There was no single reason driving these rebounds. HP's rally was more of a bounce from a terrible 2012, as years of board scandals and writedowns from overpriced acquisitions receded into history. Yahoo benefited more from its investments in Alibaba and Yahoo Japan than its core operations, while Groupon transitioned from an ephemeral daily-deals model to a more sustainable deal database popular on mobile. In most of these companies, however, the jury remains out on whether a long-lasting turnaround will come.
The return of the absurd valuation. In the second half of the year, money began flowing into brand-name Web stocks, pushing price-earnings valuations of many companies to triple-digits. That's just for companies in the red – for others losing money, a price-to-sales ratio might make more sense, but can be no less irrational.
Investors inclined to fundamental analysis get nervous when price-to-sales ratios approach 10. Google, for example, trades at 6 times its trailing 12-month sales. Twitter trades at 62 times sales while Facebook and LinkedIn are both at 19 times. Yes, investors are buying these stock for their future promise, but even based on projected earnings they're expensive: Facebook, for example, is at 48 times its estimated 2014 earnings.
The high valuations aren't yet a sign that speculation has taken over tech stocks again. Rather, much of it is coming from a shift in the broader markets. The Federal Reserve has been signaling that it's ready to taper off the generous monetary policies that have kept interest rates low and bond prices high for years. Investors are looking for areas of long-term returns to put some of that money in, and fast-growing tech companies are currently in favor. The small floats of many recent tech IPOs has added to the imbalance of demand versus supply.
The sort-of rally in large-cap tech. For several years, the biggest tech companies have underperformed the market and traded at below-average valuations. That remained the case with many companies that maintained their operations well enough and saw their stocks rise, but not anywhere near the benchmark Nasdaq: Apple, up 5 percent; Cisco, up 16 percent, Oracle, up 20 - all less than half the Nasdaq's gain. IBM declined 2 percent on the year.
Measured another way, however, there is ample evidence that money is flowing into large-cap tech as well, only because they're much more liquid the effect isn't as dramatic. Microsoft's market cap rose $88 billion in 2013, or nearly three Twitters. Google's market value increased by $139 billion to $374 billion. That increase alone is slightly larger than Facebook's $138 billion market cap.
The last-minute volatility. December brought some erratic volatility to some tech stocks that suggested that speculative trading may be entering the sector as we head into 2014. Notably, Twitter began a sudden surge in December, pushing the stock up as high as $74 last Thursday, an 83-percent gain in three weeks. Over the following four trading days, it sank 15 percent. Yet there was no news to account for either the rise or the slump.
The year-end takeaway. Where does all of this leave us as we head into 2014? Barring any big surprises, money is likely to keep flowing into tech stocks – especially those finding success in the mobile Web -- but the more that comes in, the fewer rational investment are left. Turnarounds like HP can offer low-value opportunities, but their outcomes are still far from certain. Investing in growing if unprofitable companies like Twitter may take years to pay off at current valuations.
A new crop of IPOs in 2014 should bring investors new opportunties. But if demand for them remains high, the wave of red-hot IPOs could draw even more attention and capital into the sector. That could prompt more startups that have resisted the public markets to file. It could also prompt cash-rich companies to overpay for deals now that they have to compete not just with other buyers but with the public market. Rising stock prices in an overpriced sector tends to paradoxically spur speculation. And we've seen how this movie ends before.
So count on yet another debate over Bubble 2.0? But don't engage in it because it's really a false debate. Less important than whether history will repeat itself in the Internet industry is whether investors are acting rationally or not. After all, there are many flavors of bad investing, and the dot-com bubble was only one of them.
We are extremely unlikely to see history repeat itself – it's unlikely to be as across the board as before, as the reasonable valuations of giants like Microsoft and Google suggest. But we are already seeing irrational behavior. And the pieces are in place for more irrational behavior next year. That's never good in the long run.