The weird maths of tech stocks

The sheer volume of unprofitable, high promise start-ups with valuations that assume success is another sign that markets are expensive.

The entire US taxi and limousine market generates about US$11bn in total revenue. Last November, Business Insider got hold of a 60-page internal document that indicated Uber's global revenue may have hit $2bn last year.

And how much is on-demand car service Uber currently estimated to be worth? In its most recent capital raising, Uber was valued at about US$40bn, slightly less than four times the size of the entire US taxi and limousine market.

Room-sharing service Airbnb is following a similar path. Its was recently valued at US$13bn, a price that's far higher than many of the collective valuations of the hotels it competes against. How can this be?

Bloomberg Business believes it's because 'the numbers are sort of made up'.

Value investors concentrate on items such as assets, earnings and cash flow. In start-up world, these are ignored, either because there aren't any assets and the company has no earnings or free cash flow to speak off, or the business is growing so fast they're meaningless. Uber, for example, is believed to be growing at 400% a year.

So what metrics do you use? Well, there's revenue growth, the number and growth of users and even the founder's ego.

Facebook's (NASDAQGS: FB) US$22bn acquisition of instant messaging company WhatsApp – which generated $10m in revenue and $140m in losses in 2013 – is a case in point. A purchase price of US$22bn can only be justified if you believe in stupendous growth and massive margins down the track.

And a few companies deliver on that promise. Facebook and Google (NASQAQGS:GOOGL) were valued in this way in their early days and both have, so far, delivered.

But does that mean every popular tech start-up will follow the same path? We doubt it. No one wants to miss out on the next Google or Facebook - not even Google or Facebook, apparently - and a lot of people are going to blow a lot of money as a result.

The sheer volume of unprofitable, high promise start-ups with valuations that assume success is another sign that markets are expensive. With just 14 stocks on our Buy list, half the number we had before earnings season, the Share Advisor analytical team is struggling to find value at the moment. We don't see much of it anywhere, least of all in tech stocks.

What to do? We've been building up cash in our model portfolios ready to be deployed should opportunities arise. But sometimes the best thing to do is nothing at all, which ain't easy, especially when spotty uni dropouts are hailed as visionaries for a new kind of text messaging app.

Some may recall the dotcom crash of 2000. The Internet as we understand it now was but a dream them. Many fortunes have been made since and just as many have been lost. Once again, we'll be sitting this one out, waiting for the next buying opportunity.

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