Technology stocks have made many investors rich over the years, and the right tech stock has the potential to soar if it pinpoints the next big industry trend early in its development. Yet in many cases, Wall Street has gotten far too bullish on particular tech stocks, leading their herds of investors to the slaughter as they incorrectly project past growth rates too far forward into the future.
To help identify some of these worrisome tech stocks, we turned to three of our Motley Fool contributors for their views. Read the stocks they talk about and see whether you agree with them or have candidates of your own to consider.
(Google):Google is a company that has a certain je ne sais quoi quality to it, perhaps due to its highly interesting "moonshots" -- autonomous cars, Wi-Fi balloons, and drone delivery systems -- that many forget it's currently an online advertising and search company. For example, last fiscal year 90% of Google's total revenue haul was ad-based revenue. So it is important for investors to watch closely for any risks to Google's ad dominance.
More recently, Google's been faced by the dual whammy of both lower growth aggregate paid clicks and decreased cost per click. In layman's terms, fewer people are clicking on Google's ads and advertisers are paying less for each person that does. On a year-over-year basis, the aggregate paid clicks growth rate was 25% in 2013, 20% in 2014, and fell to 13% year on year last quarter. Meanwhile, on a year-over-year basis, advertisers paid Google 8% less for click in 2013, and another 6% less in 2014. If this trend continues, aggregate click growth will slow to a level where it cannot offset cost-per-click rates and ad-based revenue growth will become stagnant.
There are many potential reasons for lower cost-per-click rates (geographical mix, product mix, and competition), but one of the most often mentioned is the continued shift to mobile. On average, advertisers pay lower rates for mobile traffic, but that may just be the tip of the iceberg for Google's mobile troubles. More recently, Apple announced it was installing a native content ad-blocking extension in iOS 9, making it harder for Google to monetize Apple's mobile traffic. Google should focus on its search and advertising problems before it works on driverless cars.
Dan Caplinger (GoDaddy): IPOs are often a place where you see overly optimistic views on an up-and-coming company, and the recent initial public offering of GoDaddy is just the latest example of how excitement can lead to a big jump in share prices. During the first few days after going public, GoDaddy shares jumped more than 30% from its open price of $20 per share, and further gains have given investors who got in on the ground floor a return of more than 50%.
Bullish investors are convinced that GoDaddy can ride its wave of unconventional marketing to lure small businesses into registering domain names and buying ancillary services like setting up websites. With a business model that relies on large volumes of customers, GoDaddy needs to get fairly high penetration among the smallest new businesses, and while that's possible, it's a task that could take time to accomplish. Investors can expect GoDaddy to swing for the fences, putting its newfound corporate riches to use with more expensive commercials and other marketing efforts. As the stock price rises, though, would-be GoDaddy shareholders are getting less margin of safety from a downturn and less potential payoff from business success. That's a recipe that no one should rush to get in on.
(Adobe): Many software companies have been moving to a subscription-based business model in recent years, and Adobe Systems is no exception. Best known for its ubiquitous creative software like PhotoShop and Illustrator, Adobe has now largely completed the transition away from perpetual software licenses, and at the end of May, the company boasted 4.6 million subscribers to its Creative Cloud offering.
While this transition was taking place, Adobe's financial results deteriorated, thanks to revenue that would have formerly been recognized immediately being spread out over the length of a subscription. Both revenue and earnings are now growing again, and Adobe expects non-GAAP earnings to rise to $3 per share in fiscal 2016, up from just $1.29 per share in fiscal 2014.
With the stock trading at around $80 per share, Adobe's valuation may not seem too unreasonable, with a forward P/E ratio of about 27 based on that $3 per share earnings target. But Adobe's strong earnings growth is deceptive for a couple of reasons. First, the company's GAAP earnings, which don't exclude stock-based compensation, will be significantly lower. Coming into this year, Adobe expected non-GAAP EPS of $2.05 and GAAP EPS of just $1.20 for fiscal 2015, and if this relationship stays the same in 2016, on a GAAP basis Adobe will only earn about $1.75 per share. This puts the forward P/E ratio at a much loftier 46.
Perhaps a larger issue, though, is that Adobe's peak GAAP earnings over the past decade was just $1.66 per share, and once Adobe gets back to this level, growth is very likely to slow dramatically. Little has changed about Adobe's core business except the way that customers pay for it, and while Adobe has invested in its digital marketing business, it doesn't have the same dominance there as it does in creative software. Once Adobe's results fully recover from the transition to a subscription-based business model, growth is very likely to slow. There's a reason why Adobe's long-term financial targets don't go past 2016.
Because of this, Adobe's valuation makes little sense. The strong growth that the company expects to report through next year can't be sustained in the long-run, and investors will be in for quite a shock when this growth disappears.
The article 3 Tech Stocks Wall Street Is Too Bullish On originally appeared on Fool.com.
Dan Caplinger owns shares of Google (C shares). Jamal Carnette has no position in any stocks mentioned. Timothy Green has no position in any stocks mentioned. The Motley Fool recommends Adobe Systems, Google (A shares), and Google (C shares). The Motley Fool owns shares of Google (A shares) and Google (C shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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