Bubble trouble

Tech is officially too hot, and even the CEOs know it.

Investors have apparently forgotten that they have suffered through two severe downturns in the past 15 years.

Driven by easy money from global central banks through quantitative easing and persistently low interest rates, and buoyed by strong returns in equity markets such as the U.S. and even Canada, investors are hungrily gobbling up any shiny new object that comes online.

Take Stingray Digital Group’s recent hot IPO. The Montreal-based company offers a music service that caters to retailers’ individual needs, and provides the music channels many people only find when their little kids try to use the remote control. It sounds a lot like Muzak, which has been around for decades, not to mention any number of the music streaming services already available. But investors piled in. Another big recent hit with investors was Shopify Inc., the Ottawabased cloud-based e-commerce platform. Its service isn’t a whole lot different than those offered by other deeper-pocketed players, but its stock has soared since its US$17 IPO in May and comfortably sits well above US$30.

Investors are flocking to a whole lot more companies than those two in the technology space. The techfocused Nasdaq composite index recently hit a record high, surpassing its previous peak in March 2000 at the height of the dot-com boom.

Even more troubling is the high level of investor complacency. Valuation confidence, one ofY ale economics professor Robert Shiller’s many telling indicators, is near its lowest level since the turn of the millennium.

In other words, professional investors have very little confidence that current equity valuations are sustainable, yet the general market doesn’t seem particularly concerned.

Maybe the market is not exactly in Pets.com territory yet, but the growing popularity of technology companies with few proprietary or unique business offerings, has many fearing a repeat of the dot.com crash that brought companies such as the online pet supply company crumbling and a big chunk of the market with it.

There is simply no more potentially frothy area of the market — other than perhaps defensive yield plays — than tech.

Even the founder of popular video messaging application Snapchat thinks we’re in the midst of a tech bubble. Evan Spiegel, whose company recently sold a small stake to Alibaba Group Holding Ltd. in a deal that values Snapchat atU S$15 billion, recently said a correction is coming in the tech sector.

He could very well be right. After all, it’s hard to believe that Snapchat, a video messaging app that lets users set a time for how long recipients can view their photos and videos, is worth US$15 billion. It’s equally mind-bog- gling that Uber Inc., the on-demand driving service, is raising money at a level that values the company at US$50 billion.

“Some of these concepts will fly and be future giants, but for every winner there are a lot of losers,” said one portfolio manager.

Let’s not forget that Facebook Inc. and MySpace were once seen as equals. Now the former dominates the social media space and is a force to be reckoned with in online advertising, while the latter has been reduced to late-night joke fodder.

The problem for investors is that it’s too early to tell where many of these companies stand on a financial basis. They need to spend a lot on things such as product development and marketing, which means putting growth ahead of profitability, while often hefty stock options cloud the actual earnings picture.

But one difference between now and the dot-com bust is that today’s companies at least seem to have proper business models. Shopify, for example, allows small and mediumsized businesses to build and run their own online stores. It’s a huge market and opportunity, and Facebook’s recent decision to add a “Buy” button for business owners registered with Shopify is the type of exciting development tech investors clamour for.

But Shopify is still losing money as it continues to build out its business, and there’s no guarantee it will ever make it into the black.

“It seems a little crazy, because there is nothing proprietary about it,” another fund manager said. “Amazon.com already does it, as do some other companies.”

Music streamer Stingray, meanwhile, has its content locked up — an asset, so to speak — and not everyone can go to its partner Rogers Communications Inc. and ask for channels. Stingray’s retail offering seems like a glorified DJ service, but companies are placing a big emphasis on setting the right mood in their stores, and it offers a plug-and-play model for that.

But it wasn’t so long ago that Mood Media Corp., which bought Muzak in 2011, appeared to have a lock on this market. Its stock is in penny territory and others may follow. With Apple Inc. and others making a push into the streaming music business, its hard to see how the smaller players won’t come under pressure.

That’s why investors looking for exposure to emerging tech trends such as cloud-based data management and software as a service (SAS), e-commerce, Web security and business analytics might want to consider more stable names. Such stocks may not be cheap, but they have history.

Waterloo, Ont.- based Descartes Systems Group Inc., for example, became one of the top players in cloud-based supply chain management software by carving out various niches, including digitizing the regulatory paperwork involved in importing goods into the U.S.

“They are a profitable SAS company and those are quite rare,” said Patrick Blais, portfolio manager at Manulife Asset Management. “It’s a less risky way to get into the sexier part of the tech space, just not as high-profile.”

Of course, that’s not to say a lot of money can’t be made in early stage tech plays.

Another Canadian company, LeoNovus Inc., is a micro-cap with a proprietary technology that also provides investors exposure to the popular cloud theme. The company’s software can link dormant set-top TV boxes in hotels with those in homes in another city, for example, to form a super-computer of sorts. It’s secure because the data is broken up into tiny pieces and duplicated in several places.

“It’s very disruptive and way lower cost than the incumbents,” said Steven Palmer, chief investment officer at AlphaNorth Asset Management.

But unless tech companies can carve out a niche for themselves, becoming acquisition fodder in the process, it’s usually the biggest players that end up on top. There will always be tech stocks that are overvalued (at least until the next crash), but finding names with leadership positions is the way to go for investors looking to speculate less — and most probably should be doing just that at this point.

There’s no doubt a lot has changed since the tech fallout at the turn of the millennium. Companies such as Amazon.com Inc., eBay Inc. and Google Inc., which were once thought of as high-flying tech stocks, are now some of the most stable and dominant players in their respective markets. But those kinds of companies don’t come around every day, no matter how hard investors try to believe otherwise.