Henderson’s Stuart O’Gorman, manager of the £391m Henderson Global Technology fund, says that the stretched valuations at the smaller end of the market remind him of the bubble of the early 2000s.
Charles Tan (pictured), analyst at Cantor Fitzgerald, says that the huge valuations on massively popular stocks such as ASOS, an internet clothing retailer, are evidence of the same dangerous trend.
O’Gorman said: "I lived through the last technology bubble and saw lots of fantastic companies that were going to take over the world and the valuations that we put on them. We are getting to the stage now for a lot of these companies where the valuation multiples are extreme." "Particularly given how shaky the global economy is, this is pretty terrifying, because valuations are basically starting to assume that these companies will win and their competitors won’t really react with pricing, that their deflationary market doesn’t cause their overall market to become less profitable."
Tan said: "I have always been quite cautious on tech in general and just looking at things like ASOS and Facebook on really punchy valuations of 60 to 70 times forward earnings, it feels like the tech bubble."
O’Gorman’s argument focuses on the lower end of the market, where he sees small tech companies with niche products and services trading on extreme valuations.
Many of these companies are yet to turn a profit, yet are trading on nosebleed prices. Tableau is trading on 592 times 2015 earnings, Splunk 284 times and Netsuite 163 times, for example.
All are examples of companies that have been in existence for some time and are achieving sales growth but no profits at all once stock compensation plans are taken into account.
"A big problem with the credit bubble we are causing is that we are enabling profitless sales growth, profitless business models to exist and to be funded."
IPOs in the sector are also seeing a 50 per cent pickup on the first day or more, reminiscent of the last tech bubble, O’Gorman warns.
"This will end in tears for these businesses but there’s also a danger this starts to affect real businesses, because it causes extremely irrational competition; basically they are selling at a loss."
"It’s not just happening in areas like cloud [computing] it’s also happening in areas like mobile handsets. I met Mediatech in Asia three weeks ago [September] - these guys supply the silicon that goes into most of these whitebox Chinese handsets - and they freely admit that very, very few of their customers make a profit, but they are funded by the Chinese government."
O’Gorman says that the larger tech stocks offer better value, and notes they are at a discount to the smaller stocks not seen since the bursting of the tech bubble.
The manager is moving his portfolio to this end of the market, but Tan thinks valuations are worrying on some large caps, too.
He notes that Facebook looks expensive on 104 times earnings, but some very popular UK stocks are also being dragged down the same route, such as ASOS on 116 times.
ASOS has seen phenomenal growth over the last decade, which has continued over the last year.
Our data shows it is up 151.06 per cent over just 12 months. The market seems to be pricing in huge overseas growth without problems, Tan says, and admits it has beaten sales expectations quarter after quarter.
Performance of stock vs index over 1yr
Source: FE Analytics
"[With these companies] people are paying for sales growth but not profit growth," he said. "Sales growth is good, but if sales growth is 100 per cent and you aren’t making anything on the margins, what’s the point? The bottom line is what is important."
Tan says everything that involves the internet is being chased after by investors desperate to find growth in a weak economy.
"With interest rates as low as they are and growth as low as it is, tech people pick up because it’s quite exciting in a low-growth environment," he said.
"Would you rather put money into a savings account at 0.5 per cent, a 10-year gilt at 3 per cent or take a punt on tech?"
ASOS has been a major holding of FE Alpha Manger Harry Nimmo for over a decade and has made his investors a lot of money.
It is also a top-10 holding for the SVM UK Growth, Baillie Gifford British Smaller Companies, Marlborough UK Leading Companies and Rathbone Global Opportunities funds.
James Thomson, the manager of Rathbone Global Opportunities, is an enthusiastic believer in stocks such as ASOS playing this theme and says he is unconcerned by their current valuations.
He also holds online estate agent Rightmove, trading on 41 times current earnings.
"Valuations for ASOS and Rightmove are high, but for the five to 10 years I have owned them they have always been high," he said.
"As growth estimates increase, so does price."
"If there was a deterioration in earnings estimates, that’s where I would get concerned, but the stocks have never looked cheap."
"It [Rightmove] is well-positioned in its market and it has pricing power. If the fundamentals deteriorated, that would be the time to look closer."
Evan Bauman, co-manager of the Legg Mason ClearBridge US Aggressive Growth fund, suggests the forthcoming Twitter IPO could be over-priced, just as Facebook’s was last year, further evidence of inflated valuations in the sector.
"Twitter has a very different model to Facebook and is at a much earlier stage in terms of monetising its business than Facebook was at the time of its IPO," he said.
"Twitter’s revenue is less than 1/10th that of Facebook and is not a profitable business (whereas Facebook was from its first quarter as a public company)."
"The recent success of Facebook will likely help Twitter to complete a successful IPO but will also likely bring the company to market at a not-inexpensive valuation."
"We bought Facebook at the time when the risk/reward was attractive. We will have to wait and see with Twitter."
O’Gorman says that his unwillingness to buy into high valuations is one of the main reasons why his fund has lagged behind the IMA Technology & Telecoms sector and the MSCI ACWI Information Technology benchmark over the last year.
Data from FE Analytics shows the fund has made 20.06 per cent while the benchmark has risen 22.4 per cent and the sector 25.93 per cent.
Performance of fund vs sector and benchmark over 1yr
Source: FE Analytics
The fund now lags its benchmark over three years but has outperformed over five and 10.
Tan says that in the closed-ended universe he prefers the £511m Herald Investment Trust, which is trading on a 13.62 per cent discount.
He describes manager Katie Potts as a "safe pair for hands" and notes that she looks for undervalued companies.
The remit of the trust is a little wider, and includes advertising company M&C Saatchi and publisher Euromoney in its top-10.
