The second "dot-com" bubble is collapsing. Here's what you need to know...
Unless you were living under a rock in 2001, you undoubtedly remember the "dot-com" bubble.
At the time, rapid changes in technology (the Internet) had investors so enamored with tech stocks that any company with ".com" in its name was instantly loved by the market, regardless of its future earnings potential.
Most of us know what happened after that.
By 2001, the bubble had burst. Investors realized companies like Pets.com, the infamous website that tried to convince us selling dog food over the Internet was a good idea, were nothing more than big dreams with little economic substance. The Nasdaq -- which traded as high as 5,132 at the bubble's peak -- was below 1,500 by July 2002.
Today, we're seeing a similar situation develop in the stock market. And if we're right, then like the "dot-com" crash of the early millennium, this event could also produce devastating losses for investors.
To understand why, all you need to do is look at social media companies...
Over the past five years, social media companies like Facebook (NYSE: FB) and Twitter (Nasdaq: TWTR) have undoubtedly been some of the market's hottest stocks. The Global X Social Media ETF (Nasdaq: SOCL), an exchange-traded fund heavily weighted toward big-name social media plays like those just mentioned, returned over 64% last year alone.
Like Internet businesses in the late 90s, today's social media stocks are loved for their story. These companies are fresh... they're youthful... and they've attracted some of the smartest minds in the business by offering flexible work hours and highly competitive compensation packages.
But while social media undoubtedly provides a great "feel good" story for investors looking to get in on the next big trend, these companies have simply not lived up to the hype when it comes to their ability to make money. In fact, many of them are bleeding cash year over year.
Take Twitter for instance. While the company has over 218 million active users, each of whom send an average of 2.3 tweets per day, Twitter has still posted annual losses in each of the last three years.
The problem for Twitter is that the display ad business -- considered to be one of the primary revenue drivers for social media companies -- hasn't proven nearly as lucrative for them as it has for their biggest competitor, Google (Nasdaq: GOOG).
Even after the recent sell-off, social media companies are sporting sky-high valuations. Just take a look at some of the top social media companies... they all look ridiculously expensive right now.
These are the kinds of numbers you would have expected to see right before the market crash in 1999. Like back then, today's investors have placed gigantic bets on these risky and unproven tech businesses. Investors who have been long in this sector have started to feel a lot of pain. As you can see in the chart below, social media stocks have been absolutely crushed...
As you can see from the chart, social media stocks -- as measured by the Global X Social Media ETF -- are down over 22% in the last 45 days. The big names in the sector like LinkedIn and Twitter are down 24% and 28% respectively, over the same period.
Whether the pain continues or not has yet to be proven. But just because we're bearish on social media companies, it doesn't mean we think investors should avoid technology stocks altogether. As Dave Forest, the Chief Investment Strategist for StreetAuthority's flagship newsletter, Top 10 Stocks, recently told his subscribers, one group of tech companies still looks very attractive given today's market conditions.
Specifically, in a recent issue, Dave told his subscribers why he thinks established tech businesses like Cisco (Nasdaq: CSCO) should continue to outperform, regardless of what happens with social media companies:
Since the last tech crash, the computer sector has come a long way. Today, home computers and even laptops are more or less a given in any developed-nation home. Throw in tablets and smart phones, and it's likely each household has several devices (I have nine in my house).
With all of that demand coming on stream, the last decade has been transformative for "tech" companies that make and sell products and services into this market. This is real business. The kind that has put over $50 billion into Cisco's coffers in less than 10 years.
The best thing is, today we're buying the earning power of Cisco at a much, much better valuation than pie-in-the-sky tech firms. Cisco sells for a current 15.1 P/E ratio -- compared to 34.8x for the wider tech sector. In fact, Cisco sells below the S&P 500 average of 18.0x.
By contrast, a stock like Facebook sells at a staggering 96.2x P/E [At the time Facebook was trading at a 96.2x P/E ratio, it has since fallen to 77.5x P/E]. Investors are betting on a big future for the company to justify this lofty valuation.
That kind of investor behavior is strikingly similar to the tech wreck, when stock buyers bet big on an unproven business.
As the technology sector continues to experience a sell-off, led primarily by social media companies, then established tech businesses like Cisco should continue to outperform. After all, as Dave says, these companies already have "real dollars-and-cents business value" behind them -- something that can't be said for high-flying social media companies like Twitter and Facebook.
So if the recent pullback in social media companies has you contemplating going "bottom fishing," just know that you could be in for a rough ride. Now that social media stocks are falling out of favor with investors they could have a lot further to fall before they start to look attractive again.
That's why instead of betting on these former high-flyers, we think you'd be better off with a proven technology business like Cisco...
P.S. -- Stocks like Cisco belong to a special group of securities Dave Forest calls "Forever" stocks. These are world-dominating companies that pay investors a fat dividend, dig a deep moat around their business to fend off competitors and buy back massive amounts of stock, boosting the value for the rest of the shares. They're solid enough stocks to buy, forget about and hold "Forever." To learn more about these stocks -- including some of their names and ticker symbols -- click here.