Netflix is a brand on the rise, but exactly how much money does it make? Picture: AP Photo/Paul Sakuma
I USE Facebook and Twitter, but I often worry about them. How, I ask, do these services pay for themselves? I’m reasonably sure I’ve never clicked on an ad, and reasonably sure I never will.
That has me concerned for the economy. A lot of big US tech companies, such as Facebook, don’t sell physical goods; they depend on getting revenue for services. And those same big companies could be the spark for the next big market crash.
The value of companies such Amazon, Netflix and Twitter is so high it is hard to comprehend. Together, they’re worth $US330 billion.
But that could fall at any moment.
Look what happened to oil. It slid from $100 to $28 a barrel in just 18 months.
Value exists only when markets agree it does. If markets change their minds on tech companies, the whole US stock market could come tumbling down.
With the way our economy follows the US, a tech crash would almost certainly be bad news for Australia.
The value of certain tech stocks is far from proven. It is still about hope. Unlike banks or retailers, investors are not buying a proven record of massive profits.
They’re buying the hope that one day profits will come. But as this graph shows, only a couple of big tech stocks make big profits.
.Source:Supplied
One way to judge stocks is by their price-to-earnings ratio (PE). That statistic gives a sense of how much the stock price depends on hope. And the PEs of some US tech stocks are out of control.
Facebook has a PE of 70. The total value of the company is 70 times the size of its earnings, so you get $1 in profit each year for every $70 you put in as owner of the company. That is a return of around 1.5 per cent, or not much different to money in the bank.
A PE of 70 is big and tells you investors are buying in hope of future profits. (The normal figure for mature companies is much lower. Woolworths has a PE of 14; Google’s is 33.)
But Facebook’s big number is still nowhere near the PE on Netflix. Which is 348.
Investors in that company expect things to get very good, fast.
The PE ratios on Amazon and Twitter are negative (both companies made losses last year) so the less said about them the better.
The point of all this talk about PEs is to point out that a lot of the value of the tech companies is in beliefs about how rosy tomorrow will be.
Lots of companies are depending on rosy tomorrows. I’ve spoken above about a few who are on the US stock exchange, because they have to make their profits and revenues public. But there are also many, many private companies with big valuations, such as Uber.
“Unicorn” is a term to describe tech start-ups worth more than $1 billion.
They got the name because they were rare. They are not rare any more.
.Source:Supplied
All of these could go on to be huge companies. Maybe. But we don’t have enough history with software to know for sure that the market for it will be like the market for shoes, hammers or coffee.
Building software is becoming very cheap. It could be that in the future getting people to pay for it is impossible. Then, the business becomes about serving ads.
As Twitter is finding, many people don’t like ads. Twitter advertising revenue is growing 60 per cent per year. But as ads have risen, growth in its active user base has fallen and is now only 11 per cent per year. Even Google is finding trouble with ad revenue.
It may be easy to imagine a world where Netflix and Twitter all get as big as Google. Some investors obviously believe that is their destiny. But there is only one Google. Many technology companies that were once dominant are now on the scrap heap.
MySpace got gazumped by Facebook, and now even Facebook is under threat from photo-sharing service Snapchat, while Snapchat is under threat from thousands of imitators. Online services can lose their customers fast if a better option comes along.
If US tech investors decide to abandon their hope in these tech companies their values could crash. I bet if that happens I’ll hear about it first on Facebook.
Jason Murphy is an economist. He publishes the blog Thomas The Think Engine.
Follow him on Twitter @jasemurphy.
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