Is this the end for the tech boom?

Facebook, Zynga and Groupon shares have tanked this year. Could the gloom spread to other technology stocks? Matthew Partridge reports.

What's happened?

It hasn't been a good year for investors in technology firms. The Facebook stockmarket flotation, the year's most anticipated offering, ended in disaster when the social network more than halved in value from its initial price of $38. Facebook's shares are still down nearly 40%. The shares of other newcomers to the public market have been hit even harder.

Zynga, which makes online games, has fallen from a peak of nearly $16 to just above $2. The declining popularity of Farmville, its best-known title, forced it to fire more than 100 staff last week.

Another high-profile flop is Groupon, which allows consumers to access discount vouchers online it is down by 80% since its flotation last November.

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The wider fear is that investors are moving away from technology companies in general. In the past few weeks Google and Apple shares have pulled back by 13% and 15% respectively from this year's highs. The S&P Information Technology Index and the tech-heavy Nasdaq have both fallen by around 10%.

How important are these firms?

The strong performance of the technology sector, with the Nasdaq doubling since early 2009, has greatly increased the valuations of related companies at all levels. However, some companies have done particularly well. At their peaks, Facebook, Groupon and Zynga had market caps of $108.9bn, $22.9bn and $12.1bn respectively. Even now, Facebook is worth $54.6bn.

But these figures pale in comparison with the mighty Apple, which has the largest market cap of any listed company in the world. Thanks to the success of the iPod, iPhone and iPad, its price has gone up by more than 90 times since 2003, giving it a valuation of $574bn, more than a third higher than energy conglomerate Exxon Mobil. The world's biggest internet search engine, Google, is in seventh place, just behind General Electric.

What has changed?

As Stephen Foley notes in The Independent, many of the original valuations of the fastest-growing firms listed in the last 18 months depended on overly optimistic projections about future profits. Poor earnings figures mean that "assumptions about these young, untested business models have had to be revised down, or pushed into the future, or called into question entirely".

Worse, as the FT's Phillip Broughton points out, many of the more recent newcomers such as Zynga and Groupon have not been genuinely innovative. "Great, well-executed ideas remain as scarce as ever. If the markets for Facebook games, daily deals on designer clothes or apps to locate our friends in bars collapsed, few would mourn them."

It's little surprise that major shareholders, such as Facebook's Peter Thiel, cashed out around the same time that their companies went public. "If one didn't know better, one might conclude that these insiders used the venture capital and IPO process to inflate their companies' valuations and then turn them into personal piggy banks."

What about Apple and Google?

Zynga, Groupon and Facebook may have been the victims of their own hype, and in Zynga's case, a poor business model. However, the downturn in Apple and Google's share prices reflects more tangible economic concerns, rather than deflating hype.

For instance, Google's sudden plunge was due to the accidental leaking of earnings data that showed growth rates levelling off, even though they are still impressive by most firms' standards. Similarly, Apple has been beset by labour problems at one of its major Chinese factories, while sales of the latest iPhone have been below expectations. Apple and Google's sheer size means that they are always vulnerable to any slowdown in the global economy.

As Jim Calamos of Calmos Asset Management puts it, "the market is fearful of the future". But combine these proper businesses' woes with the failure of some more fly-by-night operations and it's easy to be convinced that a bubble is bursting.

Is this a repeat of the 1990s?

Between 1999 and 2002, many overly hyped internet companies crashed. The day Facebook went public, technology guru Michael Wolff argued in The Guardian that, "yes, we are in a bubble". The Daily Telegraph's Willard Foxton believes the allegations of theft and fraud at Zynga are "all very reminiscent of the kind of lawsuits that flew at and in 2000, at the time of the last dotcom crash".

However, as The Economist points out, during the last bubble all firms, not just start-ups, were wildly overvalued. Cisco (the leading firm in 2000) traded at 100 times earnings. By contrast, Apple now has a price/earnings(p/e) of about 14, making any overvaluation in its stock "more like a pimple than a bubble".

LinkedIn: a rare success story

The one social media public offering that has been a success for investors so far is the business-networking site LinkedIn. When it was listed in May 2011, its shares rose from $45 to a peak of $122 on the first day (it eventually ended the day at $93), starting a debate about whether it was overvalued. Writing in The New York Times, James Stewart argued that "LinkedIn makes a good test case for the existence of a social networking bubble".

However, Business Insider's Henry Blodget defended the valuation of this "Facebook for Professionals". At the moment, the bulls seem to be winning the argument, since it is currently trading at $105. Christian Arno of Search Engine Watch thinks its strategy of targeting a specific niche has made it more attractive to investors. Right now, it looks the best of the social media plays.

Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri