Monday, November 29, 2010

Evolution of a Tech Stock: Google Works to Retain Nimble Minds

The technology sector has always been a tricky one to invest in, and this year has been no different.

Technology companies historically have had a shorter life span than most companies, and the recent pace of change has, if anything, accelerated. This makes investing in tech stocks more challenging.

For example, if you look at the valuations on some tech stocks, the "old warhorses"( i.e., Microsoft; Intel; EMC; IBM; and Oracle) are all selling at what appears to be very attractive P/E multiples. Moreover, several of these now pay reasonably good dividends.

Problem is, performance and valuation have been inversely correlated this year, with the top performers in the sector have been the smaller, "riskier" names in the group like Akami (+103% YTD) and (+98% YTD). Among the bigger companies, only Apple (+50% YTD) has been a standout performer, while stocks like IBM (+12%) have basically tracked the market.

In other words, investors in growth stocks like tech tend to focus on growth, and growth potential, than valuation. And (while I'm not sure I totally agree) it could mean that some of the tech giants that are trading at what appears to be attractive prices may be telling investors that their best days are behind them.

This morning's New York Times has an interesting article on Google which illustrates the problems that all tech companies eventually face.

Google is down -5% this year, lagging the overall market and most of the tech group. The market seems to be sensing that the company is struggling to maintain its tech edge, and the article this morning confirms this feeling. Here's an excerpt:

Google, which only 12 years ago was a scrappy start-up in a garage, now finds itself viewed in Silicon Valley as the big, lumbering incumbent. Inside the company some of its best engineers are chafing under the growing bureaucracy and are leaving to start or work at smaller, nimbler companies...

Corporate sclerosis is a problem for all companies as they grow. But a hardening of the bureaucracy and a slower pace of work is even more perceptible in Silicon Valley, where companies grow at Internet speed and pride themselves on constant innovation — and where the most talented people are often those with the most entrepreneurial drive.

Much of Silicon Valley’s innovation comes about as engineers leave companies to start their own. For Google, which in five years has grown to 23,000 employees from 5,000 and to $23.7 billion in revenue from $3.2 billion, the risk is that it will miss the best people and the next great idea.

“It’s a short step from scale to sclerosis,” said Daniel H. Pink, an author and analyst on the workplace. “It becomes a more acute problem in Silicon Valley, where in a couple years, you could have some competitor in a garage ready to put you out entirely.”

Now a Giant, Google Works to Retain Nimble Minds -

Finally, there is this to consider: some of the "hottest" companies in the tech space are still private: Facebook; Twitter; LinkedIn; and Craigslist, to name a few. These companies present formidable competitors to most of the publicly traded tech stocks, not to mention the fact that when they eventually go public there will no doubt be money flowing out of some other tech stocks.

This is what makes the tech sector interesting.