It's beginning to feel frothy in Silicon Valley. Here are a few numbers:
On the first day of its initial public offering LinkedIn was valued at nearly $9 billion; today the social networking site is worth more than $10 billion. Instagram, a company with no profits, no revenue and no plan to make money, was just bought for a cool billion. The buyer was Facebook, a firm in the process of going public.
And those values are nothing compared with what Facebook may be worth itself. That company is expected to be valued at between $80 billion and $100 billion after its IPO later this spring.
But is this a bubble? Is the considerable exuberance in this part of the world irrational?
Here in Silicon Valley you hear some version of this statement all the time: "This is different. I was here in the 1990s and these companies are not Pets.com."
Investors and entrepreneurs have been saying this to each other for years, in part because it is true. Facebook generated $1 billion in profit last year. It's still almost doubling its revenue and profit year to year and it's doing all of that with a relatively small workforce.
Instagram created a social network of 30 million people with just over a dozen employees. These companies have created ways to connect millions and build enormous audiences incredibly efficiently. That is worth something. The question is, what?
Jean-Paul Rodrigue, a professor at Hofstra University, published an influential chart just before the financial bubble burst in 2008. He broke bubbles down into four stages:
Steve Blank is a serial entrepreneur in Silicon Valley and an adjunct professor at Columbia Business School. He says we have sailed through the stealth phase of the current technology investment cycle. We are past the point where big investors are aware of the opportunities in mobile and social companies and we're rapidly entering into a period of manic excitement of the next wave of Internet companies.
But Blank says not all bubbles are created equal — not all bubbles are bad. "Bubbles built the railroads," he says. "Bubbles built the steel industry." He believes many of the technologies that are attracting so much excitement right now have the potential to change the way we live and how the economy works.
That may be. But prices are high enough now that many wonder whether companies like Facebook can justify their own hype. When investors talk about bubbles, typically they end up comparing a company's profits with its share price. The price-to-earnings ratio is a staple of evaluating a stock. ExxonMobil's P/E ratio hovers around 10. That means the company is valued at something like 10 times its annual profit.
Apple has a P/E ratio of 17. That's high compared with historical averages, but Apple's earnings have been growing incredibly fast and the company is sitting on $100 billion in cash. And its stock looks positively cheap in comparison with the latest crop of social media companies that are going public.
If after Facebook's initial public offering it's valued at more than $100 billion it will have a P/E ratio of 100 to 1. And that's a bargain compared with LinkedIn, which is trading at a ratio of between 800 and 900 to 1. These are bubblicious prices.
To justify its projected IPO price to more conventional investors, Facebook will need to double its earnings every year for the next three or four years. Those who sell now may realize windfalls and those who buy have to hope for years of exceptional growth or they will be left holding the bag.
But Blank says this may not be bad news for the economy as a whole.
"Unlike other bubbles — housing bubbles and financial bubbles — nerds don't buy yachts. They seem to reinvest in their own domain," he says.
