Sky-High in the Cloud

November 16, 2010 at 5:56 pm Leave a comment

Cloud computing is all the rage these days.  There is a huge investor demand for the shares of market leaders in the space, and as a result their valuations are sky-high.  According to Yahoo!, VMware (VMW) sports a trailing P/E ratio of 115. (CRM) trades at 205.  Rackspace Hosting (RAX) is a relative bargain at P/E of 97.  These valuations are right in line with those of many high-tech stocks during happy bubble days of late 90’s and early 2000.  This is a cause for worry.

The good news is, that unlike 2000, these exuberant price levels do not affect the whole market.  In 2000, S&P 500 P/E was pushing 50.  Nowadays, overall market is very reasonably valued, and that includes most of high-tech stocks.  Even market darlings with triple-digit prices, such as Apple (AAPL) and Google (GOOG) have very reasonable valuations.

Cloud computing is indeed at the forefront of technology today, and one could argue that the market leaders in that space deserve premium pricing.  Yet, as history has shown us many times, current valuations are simply not sustainable.  Sooner or later, as it always happens, prices will reflect the fundamentals.  It could take some time, and so I would not make aggressive bets against these stocks, such as shorting or buying puts.  As John Maynard Keynes said, “Markets can remain irrational a lot longer than you and I can remain solvent”.  But eventually they will get rational.  Buyer beware.

Entry filed under: Stock Ideas.

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Blog Author

Leon Shirman's long-term investment philosophy is summarized in his book, “42 Rules for Sensible Investing”, also available from Amazon.


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