By Ian Salisbury
Tech investing used to be synonymous with initial public offerings. But these days many pros say investors would do better to stick with Silicon Valley’s version of blue chips.
On Monday all eyes were on deal site Groupon (GRPN), which reported a modest second-quarter profit. While Groupon has won fans from consumers and merchants and enjoyed a high profile IPO late last year, disappointing growth and confusing accounting disillusioned some investors. The stock lost two-thirds of its value since debuting in November. But it’s hardly the only recent IPO to have tanked. Facebook (FB) and music site Pandora (P) have both fallen by roughly half. Video-game maker Zynga (ZNGA) is down more than 70%.
A return of the dotcom bubble? Not necessarily. Unlike in the late 1990s, there are now dozens of big companies in the tech sector that have the stability and reliable earnings that people associate with, say, ExxonMobil or General Electric. And that means money managers who specialize in tech are much less likely to chase the sexy, high-risk high-reward IPOs. Big tech companies have been an entirely different story. As a group, these have returned 5% a year on average over the past five years, handily beating the 1.5% return of the market as a whole. That success has a lot to do with Apple (AAPL), with a whopping average annual return of more than 37%. But it also owes a share to the previous generation of tech wunderkinds made good, like Amazon.com (AMZN), Google (GOOG) and eBay (EBAY) — stocks that have all survived their awkward IPO years.
While these giants no longer offer the win-the-lottery upside associated with IPOs, some portfolio managers say they’d rather funnel their tech investment dollars to companies with established business models and stock prices that look relatively low compared with their annual profits. “With Apple at 12 times earnings, why would I Iook at Groupon or Pandora?” says Fritz Reynolds, manager of the $180 million Reynolds Blue Chip Growth fund, who also owns eBay and Amazon.com.
Another problem with younger tech companies, say managers: Since many go public before they are consistently in the black, investors have to look elsewhere — often to revenue — to judge the right price. While Groupon shares may appear cheap after their huge decline, they still trade at 1.8 times annual sales, compared with 1.3 times for the market as a whole. Since there is no guarantee revenue will eventually turn into profits, investors can be demanding about how quickly sales are growing.
“When you’re priced to multiples of revenue, every single number needs to be perfect.… People are jumpy,” says Joshua Stewart, comanager of the $140 million Wasatch World Innovators fund, whose top holdings are Apple and Google but who hasn’t bought the more recent crop of tech companies, including Groupon.
By contrast, the last decade’s risky-seeming tech bets often look solid today. While Apple’s now giant size raises questions about how many more iPhones and iPads it can sell, the company trades at about 12 times its $40 billion-plus in expected annual profits. Some tech managers say that’s too good a deal to pass up.