As many people know, one of the hottest areas in the market right now is technology stocks. Investor sentiment has continued piling into this sector—with good reason in some cases.
The danger for investors is when investor sentiment becomes too bullish—technology stocks might be entering this territory.
The latest of the technology stocks that has announced it is going public is the Chinese powerhouse Alibaba Group. Started in 1999 by a former English teacher, the company has now grown to be the largest e-commerce company in China and will soon be a public firm with a valuation of more than $140 billion.
While it can be said that investor sentiment has become too enamored by recent technology stocks such as SnapChat, which doesn’t generate any revenue or earnings, Alibaba is a real business producing billions of dollars in revenue.
For American investors, the biggest beneficiary of Alibaba has been Yahoo! Inc. (NASDAQ/YHOO). Over the past year, as rumors continued to circulate that Alibaba would go public, investor sentiment has become ever more bullish on Yahoo!, since the firm owns 24% of Alibaba.
This could be a “buy on rumor, sell on fact” event, as investor sentiment has pushed Yahoo! to multiyear highs amid a backdrop of both positive investor sentiment towards technology stocks and a buildup in anticipation for the initial public offering (IPO) of Alibaba.
If investor sentiment continues to be overly bullish for technology stocks in general and Alibaba specifically, what will happen is that the IPO price and the subsequent trading activity will capture a huge premium to the current business environment.
This is great for Yahoo! at the moment, but if the current share price already incorporates the high valuation of Alibaba, what’s the next catalyst for Yahoo! itself? I think it’s questionable, considering the firm’s actual business model is having trouble growing revenue at all and competition continues to increase.
With a forward price-to-earnings (P/E) ratio of almost 22 and trading at over eight-times its sales, I think these are pricey metrics considering that the fundamental business is not exactly on fire. Looking at other technology stocks, there appear to be several favorable comparisons where I would think about taking profits in Yahoo! and reallocating these funds into firms that are actually increasing revenue at a significant pace.
Domestically, an obvious competitor is Google Inc. (NASDAQ/GOOG), which has a forward P/E ratio of over 19 and trades at 6.5X sales. While revenue has decelerated, it’s certainly growing at a faster rate than Yahoo!
An international opportunity that has recently emerged is in Yandex N.V. (NASDAQ/YNDX). This is a leading search engine in Russia that has seen its shares drop due to the crisis in Ukraine. However, the company is growing revenue at almost 40% year-over-year, and it trades at a lower multiple than Yahoo!
An important point to consider is where investor sentiment is for various technology stocks, and try to find opportunities when a stock becomes too bullish or too bearish.
By taking advantage of investor sentiment moving to the extremes, one can look to take profits from technology stocks that have moved up rapidly and reallocate their capital to technology stocks that are experiencing short-term downdrafts. As long as the long-term fundamentals remain sound, short-term aberrations can become great long-term opportunities.
While I believe Alibaba will be a great IPO success story for Yahoo! over the short term, once people begin to look at the underlying business again, it is possible that investor sentiment might begin to weaken from the lofty highs currently placed on that stock.
This article How a Giant Chinese Tech IPO Will Benefit These Other Top Stocks was originally published at Daily Gains Letter