19 November 2013

DropBox: Look Out Below

In a spiral galaxy near a solar system on a blue marble with slightly less carbon-dioxide than what we have today, there was a world of people buying stock that actually knew what they were buying. They would never have bought a company making lockers for 8 billion. Laughed at a company giving free bird-shaped sticky notes valued at 30 billion. Never considered a company selling sticks to poke people and bulletin boards to tell others how you are doing today for 100 billion. That beautiful place where people used logic in their investment choices is unheard of to many.

Yes, Facebook is not worth 100 billion. Twitter, which has nearly zero revenue stream, is not worth 3 billion, let alone 30 billion. And how the hell does a company that does nothing more than store files that we upload to them get valued at 8 billion?

Cloud services are, by definition, easily replaceable. The younger demographic of customers are fickle. If
you get sick of DropBox you can switch to Google Drive or Box in a couple of minutes. I am not saying these tech stocks are worthless. (Well, Twitter currently is, but I digress.) What I am saying is that the people buying them are not paying attention.

The first thing a real investor should look at is the P/E ratio to determine how their stock price compares to their actual earnings. Is the number between 0 and 10? Then they are bringing in earnings that nearly match their valuation and that is an ideal pick. Between 10 and 20 is an acceptable risk provided the company has a solid market. The higher the number goes the more unrealistic their stock price is compared to what they actually bring in. Is the P/E ratio blank? That means they are losing money and you need to ask whether you should risk your hard earned dollars on a company that cannot turn a profit.

We all need to get to know what a company sells or potentially could sell in the future. Determine their likelihood of achieving their future goals of expansion, which can give you a sense of how high their stock could go. Finally, you need to realistically evaluate how easily their service could be replaced.

Let's start with the music service called Pandora. Today it has a valuation of 5 billion. We all love streaming music, but they are losing money. Worse yet, their are a half dozen other major cloud music stations to pick from and none of them are making money, either. The audience is used to switch stations to listen to their favorite tunes, so what incentive do I have to stay with Pandora? Pandora is worth only a fraction of their current evaluation.

Facebook is used by nearly every person over 30 on the planet and is the go-to location for talking to "friends", though the definition of that word is up for debate. They make money by selling ads but their ratio is five times higher than the barely-acceptable 20 level. Facebook membership is stagnating in major markets today, they do not have a clear roadmap on how to increase advertising sales and, worst of all, the younger generation prefers to use Twitter. Again, Facebook is worth a fraction of their current evaluation.

Speaking of Twitter ... What the hell? It is an online text message service, folks, and one that has no current way to make any profit at all, let alone one that justifies a 30 billion or 40 billion evaluation. I understand that kids love it but they need to find a business model that brings in revenue before I would waste a single dollar on this stock.

So, if these are the basic steps a real investor would do and good investors would clearly stay away from these things, why is anyone buying them? It is another tech bubble caused partially by empty heads on TV that justify ridiculous evaluations and mutual funds that simply select a stock regardless of whether it has a business model that justifies the asking price.

Potentially all of these over-priced stocks can make you money because stock changes are very susceptible to lemming behavior. When people see Facebook going up they put it on their "buy" list, because clearly stocks only go one direction, which forces the price even higher. However, when you have a market going from 7,000 to 16,000 since Obama has been in office, it is clear that there is plenty of downward pressure building. So be careful and make certain you are investing in companies that have limited room to fall. It is good to look at the sky when projecting your own career but when you are investing you should always look out below.