Has tech bubble 2.0 just burst? And how can you profit from it?

Tech stocks have had a bad few days. And there are likely to be further falls. But it’s not all bad news. Ed Bowsher explains how patient investors could profit.


Tech stocks may have further to fall

Technology company shares are on the slide.They had a bad day on Friday, and continued slipping yesterday.

In truth, the slide isn't that surprising. Some tech stocks were hugely over-valued, and most people could see that.

So is this the end of Tech Bubble 2.0?

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But I think that selling out of the sector in a panic would be a big mistake. Some of these companies will be long-term winners. You just need to be discerning - and patient.

The biggest casualties of the tech crash so far

Facebook (Nasdaq: FB) fell 7% on Friday alone and is down 22% over the last month. Twitter (NYSE: TWTR) is down 20% over the last month and has crashed 31% since the start of the year.

But it's not just social media companies getting caught up in the carnage. Internet retail giant Amazon (Nasdaq: AMZN) is now down 20% since the beginning of the year, while online broadcaster Netflix (Nasdaq: NFLX) is down a huge 23% over the last month.

The rout in the tech sector is starting to unnerve other parts of the market too. That's not a huge surprise either the US as a whole is rather over-priced.

So why has the slump hit now?

You can never be sure about things, but there's certainly been a growing awareness that some tech valuations had become very stretched. Some recent corporate deals in Silicon Valley have merely highlighted just how carried away investors were getting. One example is Facebook's recent purchase of Oculus, a virtual reality company.

To pay $2bn for what is little more than a start-up suggests a lack of confidence on the part of Facebook founder Mark Zuckerberg in his company's core business. If he's desperate enough to pay that for an unproven bolt-on to Facebook, then what does that say about prospects for growth?

And when you see that lack of confidence, you start to wonder if Facebook really merits a price/earnings (p/e) ratioof 70. (That was Facebook's p/e a month ago now it's 57.)

Of course, even when shares are expensive, they can still rise further. That's because most of the investors holding them don't want to sell, in case they miss out on further gains.

But when prices fall for more than a day or two, fear of missing out on further gains turns into fear of losing your paper profits. So lots of people rush to the exits to lock in their gains. Momentum goes into reverse.

That appears to be happening now.

I also suspect that at least some tech stocks have further to fall. One reason is the pending listing of Alibaba, the Chinese internet giant.

One broker has suggested that the valuation for Alibaba could be as high as $190bn. Given the recent tech sector falls, the valuation probably won't be that high. But even if Alibaba floats at just $80bn, that could still suck a lot of money away from other tech stocks.

A bargain hunter emerges

Mark Mobius, the highly respected fund manager of the Templeton Emerging Markets Investment Trust, has told Bloomberg that he's been buying some Asian technology shares.

He refused to reveal exactly which stocks he's buying. But he did highlight Tercent, another large Chinese internet company. Mobius said: "If you look at Tercent, for example, it's come down about 20% and that's a pretty good correction."

For what it's worth, I'm not selling my tech stock holdings either. I accept that they all may have further to fall in the short-term, but I'm happy with my choices and I'm pretty confident that they will prosper in the long-term.

Google (Nasdaq: GOOG) is well placed to dominate the web for many years to come. Yet it's now trading on a p/e ratio in the high teens.

I also remain positive on my holding in Amazon. Now I admit the company looks very expensive on several metrics. But you have to remember that Amazon has a history of investing heavily to develop new markets for the business, and it also sells goods and services on very low profit margins.

Low margins don't help profits in the short term, but they do help to drive rivals out of business. With reduced competition, Amazon should be able to push up at least some of its margins in the medium term.

So in summary yes, tech stocks may have further to fall. But not all tech shares are trading on crazy valuations.

So you should look for opportunities to buy up the quality ones at cheaper prices if they get dragged down by a their more over-valued peers.

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Ed has been a private investor since the mid-90s and has worked as a financial journalist since 2000. He's been employed by several investment websites including Citywire, breakingviews and The Motley Fool, where he was UK editor.


Ed mainly invests in technology shares, pharmaceuticals and smaller companies. He's also a big fan of investment trusts.


Away from work, Ed is a keen theatre goer and loves all things Canadian.


Follow Ed on Twitter or Google+.