Are we Headed for a Second Tech Bubble Burst?

Cartoon via The Economist

Whether you work in the technology sector or want to invest, you need to know the signs of a tech bubble. This refers to an imbalance between the value of tech stocks and the actual value of the business. Recognizing a bubble isn’t an exact science, but there are some warning signs.

The Last Tech Bubble Burst

The last time a tech bubble burst was in the late 1990s, after the infamous dot-com bubble. During that time, companies failed en masse after their business models failed to live up to investor speculation.

The actual value and profitability of companies was far less than the value of stocks driven up by speculation on future returns. One clear sign of a bubble is a rapid rise in the value of tech stocks without a corresponding rise in corporate profitability.

New Tech Stocks

There is a marked difference between the dot-com bubble and the current economic environment. A technology stock today is far more likely to be based on a viable business model. The survivors of the first bubble burst–most notably Amazon.com, which wasn’t profitable until 2004–provide a road map toward avoiding a preponderance of flash-in-the-pan hot tech stocks.

Tech Stock Index

One way to gauge if there is a tech bubble is to look at technology stock values generally. These can be found in the tech stock index. There are two main indices for tech stocks in the United States:

1. The Cleantech Index measures the total value of all the major companies developing clean energy technologies.
2. The Dow Jones U.S. Technology Index measures the total value of all technology stocks on the Dow Jones list.

When tech stock indices rise without a corresponding increase in profitability, this is a clear sign of a tech stock bubble.

Profitability Versus Profit Potential

A lack of profitability doesn’t create a bubble all on its own. Amazon.com is a prime example of a company that hemorrhaged money for years before becoming a retail powerhouse. During the dot-com bubble, nearly anyone could get venture capital, no matter how ill conceived and flimsy the business model.
The number of IPOs is a good way to gauge if there is an impending tech bubble burst. In 1999, no fewer than 308 companies had an initial public offering in the tech sector. In 2011, this number is a mere 25, with most of the money going to the older businesses with profitable models such as LinkedIn.

Watch More: What Tech Bubble?

Best Tech Stocks 2011

The best tech stocks this year tend to be companies who actually make things. Examples of hot tech stocks insulated from a tech bubble burst include:

• Teradyne manufactures test equipment invaluable to producers of computer chips and telecommunication equipment.
• LinkedIn finally turned a profit in 2010, to the tune of $12 million.
• Oracle leads the field in database software, an essential component of today’s internet and business environment.
• Broadcom manufactures semiconductors for products such as cable boxes, modems and office and home networks.
• Zynga makes famous social games such as CityVille, FrontierVille and FarmVille. The company posted a 35 percent margin in 2010, making this one of the hottest tech stocks going.
• Apple occupies an increasing percentage of the market. The iPad has quickly come to dominate the tablet market, with iPod being synonymous with the MP3 player.
• Juniper Networks designs and manufactures hardware and software for Internet Protocol network services and products.

Bio Tech Stocks

When most people say “tech stocks,” they’re usually referring to computer- and internet-related firms. However, investing in biological technology companies are a way to invest soundly in technology without being subject to the whims and vagaries of the internet. Bio tech has wide applications in medicine and agriculture. Best of all, most bio tech firms are involved in the manufacture of goods or providing real services. There are three main types of bio tech stocks, from the safest investment to the least safe:

• Companies such as Amgen, Genzyme and Immunex that are well established, profitable and have products on the market.
• Companies with one product on the market or those looking to release their first product. These companies are not profitable yet and involve significant risk. Examples of this type of company includes Human Genome Sciences, IDEXX Labs and Affymetrix.
• Everyone else. These are companies struggling to raise capital and having trouble getting their products to market.

Then and Now

During the last tech bubble, there were literally hundreds of companies with poor business models trying to sell products and services to a small user base. In 2010, ten times as many people were on the internet as there were in 2000. Indeed, there are more active Facebook users today than internet users in 2002. While there might be an increased value in internet and technology companies, this similarity alone does not a technology stock bubble make.