6 ways to play the mini-bust in tech
A market correction is like pruning a rosebush. In the tech sector, it's easier than you think to spot the buds that matter.
Pity the stock market, down some 4 percent since the Standard & Poor's 500 Index ($INX) closed at a record high of 1,891 on April 4. It's an old game to mock Wall Street's short-term obsessions, but the extant notion of a few down days being a new bear market is a doozy.
That said, lots of stocks have been hit much harder. According to Strategas Research Partners, at least 17 percent of S&P 500 stocks have pulled back 10 percent or more. Tech has its share of corrections that hurt, hitting even darlings like Netflix (NFLX), down 28 percent; Tesla (TSLA) 20 percent and Pandora (P) 36 percent.
In an improving economy, tech's bounce back isn't a serious question -- the issue is how to play it.
Small investors should apply a two-fold screen: Is the company I'm eyeing either huge and dominant, or is it changing everything? Amid some chaff, plenty of tech's current crop of companies embody genuine megatrends like cloud computing, green technology and health information technology. It’s nice if they also have cheap shares, but for truly disruptive or dominant companies, "cheap" is relative.
Here are picks that play on ideas that will still matter when the market stops panicking. If they're expensive, there's good reason. Some are getting downright reasonable.
The consumer rebound: Priceline
It's hard to name two bigger consumer trends than the recovery from the financial crisis and developing nations' move into the middle class. As a play on both, Priceline (PCLN) at less than 23 times earnings (after a 15 percent drop) is actually cheap. No major U.S. stock will gain more from a European consumer-confidence recovery than Priceline, which gets more than 80 percent of its earnings internationally. Rival online-commerce leaders Netflix and Amazon (AMZN) are far pricier.
The green revolution: Tesla
There aren't many bigger ideas than slashing fossil-fuel use. And with Tesla able to sell high-end cars faster than it can make them, especially in China, estimates that it will sell 35,000 cars this year are just the beginning.
Its stock is still at 115 times this year's earnings, so skepticism is fair. But imagine Tesla selling 100,000 cars yearly for $50,000 each, rolling out cheaper models to expand their market and complement the Model S. Plug in the company's target for margins in the low to mid-teens as a percentage of revenue, and my math says pre-tax cash profit hits $750 million in four years, probably less. In that light, the $25 billion valuation looks intelligently aggressive.
Promotional materials for Tesla's gigafactory to make electric-car batteries estimate that Tesla will sell 500,000 cars a year by 2020, so betting on 100,000 by 2017 is pretty conservative. Figure Model S sales near the current 1,000 a week, Model X sport-ute sales about the same (CEO Elon Musk recently endorsed those numbers, and both those cars will cost more than $50,000). Then figure that the Model E sedan, due around 2017, will target a segment where Audi, BMW and Mercedes sell almost a million A4s, 3 series and C classes a year. Pick Tesla's share of that market -- 10 percent, 25, whatever -- and the case explains itself.
Health-IT: Castlight Health
I'll stick up for a call from before the March 14 IPO of this health-care data company, which lets self-insuring companies contain health costs. I said Castlight (CSLT) was worth more than the then-proposed $1 billion valuation. I was thinking $2 billion. Castlight zoomed to $4 billion after its IPO, and is now worth $1.5 billion. Right where I like it.
The horse Castlight is riding is tax penalties on so-called expensive, premium health plans, which take effect in 2018. The deadline will make Castlight grow as companies scramble to keep premiums under the "Cadillac tax" threshold, just as a similar legal deadline has propelled electronic medical-records companies.
Castlight may not work out: It’s very young and had only $13 million of reported revenue last year. But it has a $100 million contract backlog, health-care reform is a huge idea, and Castlight has much more room to grow than more mature EMR companies like Cerner (CERN).
Social networking: Facebook
At 46 times this year's estimated earnings, Facebook's (FB) not that expensive after an 18 percent drop since March. Here’s a more important number: When it filed to go public, a Facebook venture investor anonymously explained that Facebook's business case was about increasing revenue per user to $20 a year from about $4.
In two years, that has risen to $6.40 -- enough to show the strategy's working, but nowhere near exhausting Facebook's potential. Its stock is half as expensive as LinkedIn (LNKD) while Twitter's (TWTR) valuation (down 46 percent) is still almost twice what pundits thought it was worth before its IPO.
Cloud computing: Workday
Workday (WDAY) makes financial management, human resources and other software for the cloud. It’s not profitable yet, but has $1 billion-plus in yet-unrealized backlog and other billings, about three times last year’s subscription revenue.
With the company expanding internationally and cloud computing taking market share, Workday has a long way to run -- more than enough to recapture shares' drop of about 35 percent since March. At 15 times this year's revenue, the stock price is high, but commensurate with the reward.
Online marketing: Google
At 20 times 2014 earnings estimates, the world's biggest online-ad seller is a gimme. Dominant in search, taking share in mobile, the leader in Web video, Google's (GOOG) stock price is 16 times 2015 profit estimates after a 12 percent drop or so. Some bubble.
A market correction is like pruning a rosebush -- healthy branches produce bigger blooms than ever. In tech right now, it's easier than you think to spot the buds that matter.
--Tim Mullaney created the BusinessWeek Web 20 model portfolio and was national economics correspondent for USA Today.
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