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Dot-Com Stocks Are Plunging -- Time To Buy?

The past month has been tough for tech stocks.

The Nasdaq composite index hit a recent peak of 4,358 on March 5 -- but has slid more than 5% since then. That figure may be a bit deceiving. Many stocks in the tech index have managed to hold their ground, but some of the most richly valued tech stocks are now drifting quite far from their peaks.

Roughly three weeks ago, I took note of these slumps, and the selling has continued since then, with many of 2013's hottest tech stocks now off 20% or more from their recent peaks.

To be sure, nobody would call these tech stocks bargains, even after they've sold off. But as these stocks grind lower, it's time to assess which ones may be close to a floor and poised for a rebound.

For example, Oppenheimer analyst Jason Helfstein, who previously rated Netflix (Nasdaq: NFLX) and Yelp (Nasdaq: YELP) as "perform" (meaning neutral), just boosted his ratings on these stocks to "outperform." Regarding Netflix, he notes that the $120 plunge from a month ago is partially attributable to concerns that (Nasdaq: AMZN) will soon launch a set-top box suitable for video streaming, creating a clear adversary for Netflix. Helfstein's view: "We think the AMZN (set-top box) will actually be a positive for NFLX, as a featured application." A key potential catalyst for the stock: He thinks Netflix will deliver 50% subscriber growth in 2015 in its international markets.

Investors are still asked to take industry valuations with a large grain of salt: Helfstein's new $78 price target for Yelp (which reflects 20% upside) assumes that shares will trade up to 15 times projected 2018 earnings before interest, taxes, depreciation, and amortization (EBITDA). And that assumes that Yelp meets his aggressive growth forecasts, which include 49% sales growth in 2015.

To be sure, such price targets are more art than science. After all, when shares of Yelp traded for around $100 a month ago, implying stratospheric valuations, some investors saw grounds to buy shares at that time. Sentiment around such stocks had made it impossible to apply any sort of fundamental analysis, at least until a month ago. Indeed, the era of "buy them at any price" may have ended for such stocks.

Though no stocks in this group yet pass a solid sniff test in terms of valuations, I am becoming a convert to LinkedIn's (Nasdaq: LNKD) stock, especially as the wind has come out of its sails. Part of the downdraft is due to a management decision to ramp up expenses in 2014 in support of growth.

That's a wise long-term move, but it can spook investors focused on the short term. You can see the impact of those higher expenses in consensus 2014 earnings per share (EPS) forecasts, which have slid from $2.20 to $1.60 over the past three months (and will likely be flat with 2013 levels).

To get a sense of whether shares hold value, it helps to look at the long-term trajectory of this business model. To be sure, the projected modest dip this year in EBITDA margins is concerning. These automated dot-com business models should always be capable of generating rising margins, as each incremental dollar of revenue flows to the bottom line.

LinkedIn's Growth Metrics

Flickr/Nan Palmero
LinkedIn is still one of the pricier stocks out there, but it's noticeably cheaper than some of its dot-com peers.

Management says the current boost in spending is to help accelerate the company's launch in China and add more functionality to its U.S.-focused website. Analysts at UBS expect that should fuel further margin gains starting next year. At maturity, this business model should be capable of 36% EBITDA margins, which is one of the reasons that investors embraced dot-com stocks in recent years.

So what's the right price for this stock? Trading at 10 times UBS' projected 2018 EBITDA (on an enterprise value) basis, this is still one of the pricier stocks out there, but noticeably cheaper than some of its dot-com peers.

UBS' view of the stock when fourth-quarter results were released in February is instructive. At the time, with shares trading above $220, the analysts found them to be fully valued and applied a "neutral" rating and a $230 price target. (Merrill Lynch eyed a $232 price target while Goldman Sachs has a $256 price target.)

UBS' analysts, speaking for the crowd, figured that share price upside was limited, adding that "investors will reward LinkedIn with higher multiples if revenues demonstrated re-accelerating growth on the back of new initiatives, such as Sales Navigator, Marketing Solutions or a China expansion."

Yet shares now trade for a lot less than those price targets. And that reason alone may trigger a cycle of upgrades when first-quarter results are released later this month. Thus far during the recent sell-off, most analysts (besides Oppenheimer's Helfstein) have refrained from weighing in on the newly lower stock prices in this sector. But in the case of LinkedIn, with price targets remaining in the $230 to $256 range those current "neutral" ratings may soon be "buy" ratings.

Risks to Consider: Dot-coms are still richly valued and could head well lower if the Nasdaq enters into correction territory.

Action to Take --> Beauty is in the eye of the beholder with these stocks, and it was simply hard make any sort of investment case for them when they were surging to new heights in recent years. But with share prices retreating by 20% or 30%, selective buys are starting to emerge. Oppenheimer sees value in Netflix and Yelp, and investors should also give a fresh look at LinkedIn.

P.S. An eccentric Texas woman who dodged the 2008 financial collapse says the market is ripe for a pullback. This is the same analyst who's produced annual returns of up to 510% and has picked winning investments roughly 85% of the time. To learn how she's protecting her portfolio today, click here.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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