The second "dot-com" bubble is collapsing. Here's what you need to know...

Unless you were living under a rock in 2001, you undoubtedly remember the "dot-com" bubble.

At the time, rapid changes in technology (the Internet) had investors so enamored with tech stocks that any company with ".com" in its name was instantly loved by the market, regardless of its future earnings potential.

#-ad_banner-#As a result, the Nasdaq Composite Index soared 550% between 1995 and the year 2000...

Most of us know what happened after that.

By 2001, the bubble had burst. Investors realized companies like Pets.com, the infamous website that tried to convince us selling dog food over the Internet was a good idea, were nothing more than big dreams with little economic substance. The Nasdaq -- which traded as high as 5,132 at the bubble's peak -- was below 1,500 by July 2002.

Today, we're seeing a similar situation develop in the stock market. And if we're right, then like the "dot-com" crash of the early millennium, this event could also produce devastating losses for investors.

To understand why, all you need to do is look at social media companies...

Over the past five years, social media companies like Facebook (NYSE: FB) and Twitter (Nasdaq: TWTR) have undoubtedly been some of the market's hottest stocks. The Global X Social Media ETF (Nasdaq: SOCL), an exchange-traded fund heavily weighted toward big-name social media plays like those just mentioned, returned over 64% last year alone.

Like Internet businesses in the late 90s, today's social media stocks are loved for their story. These companies are fresh... they're youthful... and they've attracted some of the smartest minds in the business by offering flexible work hours and highly competitive compensation packages.

But while social media undoubtedly provides a great "feel good" story for investors looking to get in on the next big trend, these companies have simply not lived up to the hype when it comes to their ability to make money. In fact, many of them are bleeding cash year over year.

Take Twitter for instance. While the company has over 218 million active users, each of whom send an average of 2.3 tweets per day, Twitter has still posted annual losses in each of the last three years.

The problem for Twitter is that the display ad business -- considered to be one of the primary revenue drivers for social media companies -- hasn't proven nearly as lucrative for them as it has for their biggest competitor, Google (Nasdaq: GOOG).

Even after the recent sell-off, social media companies are sporting sky-high valuations. Just take a look at some of the top social media companies... they all look ridiculously expensive right now.

These are the kinds of numbers you would have expected to see right before the market crash in 1999. Like back then, today's investors have placed gigantic bets on these risky and unproven tech businesses. Investors who have been long in this sector have started to feel a lot of pain. As you can see in the chart below, social media stocks have been absolutely crushed...

As you can see from the chart, social media stocks -- as measured by the Global X Social Media ETF -- are down over 22% in the last 45 days. The big names in the sector like LinkedIn and Twitter are down 24% and 28% respectively, over the same period.

Whether the pain continues or not has yet to be proven. But just because we're bearish on social media companies, it doesn't mean we think investors should avoid technology stocks altogether. As Dave Forest, the Chief Investment Strategist for StreetAuthority's flagship newsletter, Top 10 Stocks, recently told his subscribers, one group of tech companies still looks very attractive given today's market conditions.

Specifically, in a recent issue, Dave told his subscribers why he thinks established tech businesses like Cisco (Nasdaq: CSCO) should continue to outperform, regardless of what happens with social media companies:

Since the last tech crash, the computer sector has come a long way. Today, home computers and even laptops are more or less a given in any developed-nation home. Throw in tablets and smart phones, and it's likely each household has several devices (I have nine in my house).

With all of that demand coming on stream, the last decade has been transformative for "tech" companies that make and sell products and services into this market. This is real business. The kind that has put over $50 billion into Cisco's coffers in less than 10 years.

The best thing is, today we're buying the earning power of Cisco at a much, much better valuation than pie-in-the-sky tech firms. Cisco sells for a current 15.1 P/E ratio -- compared to 34.8x for the wider tech sector. In fact, Cisco sells below the S&P 500 average of 18.0x.

By contrast, a stock like Facebook sells at a staggering 96.2x P/E [At the time Facebook was trading at a 96.2x P/E ratio, it has since fallen to 77.5x P/E]. Investors are betting on a big future for the company to justify this lofty valuation.

That kind of investor behavior is strikingly similar to the tech wreck, when stock buyers bet big on an unproven business.

As the technology sector continues to experience a sell-off, led primarily by social media companies, then established tech businesses like Cisco should continue to outperform. After all, as Dave says, these companies already have "real dollars-and-cents business value" behind them -- something that can't be said for high-flying social media companies like Twitter and Facebook.

So if the recent pullback in social media companies has you contemplating going "bottom fishing," just know that you could be in for a rough ride. Now that social media stocks are falling out of favor with investors they could have a lot further to fall before they start to look attractive again.

That's why instead of betting on these former high-flyers, we think you'd be better off with a proven technology business like Cisco...

P.S. -- Stocks like Cisco belong to a special group of securities Dave Forest calls "Forever" stocks. These are world-dominating companies that pay investors a fat dividend, dig a deep moat around their business to fend off competitors and buy back massive amounts of stock, boosting the value for the rest of the shares. They're solid enough stocks to buy, forget about and hold "Forever." To learn more about these stocks -- including some of their names and ticker symbols -- click here.

Related Articles
  1. Stock Analysis

    How Much Coca-Cola Spends on Advertising

    Learn about Coca-Cola's ad spending and why the company has decided to spend the amount of money it does. Understand comparable companies and industries.
  2. Investing

    Welcome Back, Volatility

    Volatility is likely to resurface as the Federal Reserve gets closer to adjusting its monetary policy stance, even if that adjustment is a measured affair.
  3. Economics

    What Is The Labor Market Conundrum?

    We are facing a conundrum with investment implications: Why are wages still stagnant, when jobs are being created at the fastest pace since the late 90's?
  4. Investing

    Why Are Consumers In Hesitation?

    Diverging monetary policy globally and a stronger dollar continued to be key drivers of the recent underperformance and last week’s tumble in U.S. stocks.
  5. Economics

    Bulk Shipping Companies Struggle As Markets Soften

    The "soft" dry bulk shipping market that confronts shipping companies is a result of lower demand from China, and an excessive amount of bulk ships.
  6. Stock Analysis

    Sierra Wireless Benefits From These Megatrends

    We take a closer look at how Sierra Wireless' transition from 2G to 3G and 4G technologies, has impacted its business today, and the future expectations.
  7. Stock Analysis

    3 Growth Opportunities For ARM Holdings

    ARM Holdings highlighted several growth opportunities in its most recent roadshow presentation. Here are three of the large opportunities it talked about.
  8. Stock Analysis

    Is Cheniere Energy Still On Track For 2016?

    The energy boom in the U.S. has opened up a huge range of opportunities in the oil and gas industry.
  9. Stock Analysis

    What’s The Key To Costco’s Extraordinary Success?

    Costco has been one of America's most successful companies: It's growing, efficient, profitable and its long-term shareholders have benefited a windfall.
  10. Stock Analysis

    Can American Capital Agency Maintain Its Dividend?

    Dividend investors know that real estate investment trusts with REITs that invest in mortgage-backed securities produce double-digit dividend yields.
RELATED TERMS
  1. Fractal Markets Hypothesis (FMH)

    An alternative investment theory to Efficient Market Hypothesis ...
  2. Core Durable Goods Orders

    New orders for U.S. core durable goods, which are the total durable ...
  3. Investopedia

    One of the best-known sources of financial information on the ...
  4. Market Depth

    The market's ability to sustain relatively large market orders ...
  5. Closing Tick

    The difference between the number of stocks that closed higher ...
  6. Institutional Brokers' Estimate ...

    A system that gathers and compiles the different estimates made ...
RELATED FAQS
  1. What is the long-term outlook of the metals and mining sector?

    An industry agency council was established by the World Economic Forum in 2014 to serve as an advisory board on the future ... Read Full Answer >>
  2. What is the railroads sector?

    The railroads sector is comprised of publicly traded stocks for companies that operate railroad tracks and/or trains. Railroad ... Read Full Answer >>
  3. Who are Amgen Inc.'s (AMGN) main competitors?

    Biotech giant Amgen Inc (AMGN) bills itself as one of the first biotechnology firms. It was founded in 1980 and has grown ... Read Full Answer >>
  4. What's the most expensive stock of all time?

    Back in late August 2012, Apple’s (AAPL) stock price reached nearly $700 per share. The stock has since split but has yet ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!