Don't Buy the Tech Hype

June 8, 2010 - PRLog -- Apple Inc.  (and the rest of the tech industry for that matter) has a way of building up hype. Despite prototypes of the of the firm's iPhone 4 leaking out, there was still enormous anticipation as Steve Jobs took the stage at Apple's developers' conference to officially introduce the new smartphone.

From the mainframe era to the early dot-com craze to today, the industry has been expert in hyping its products and informing us how they are going to change our lives. The buzz surrounding the emerging tablet market among others has led tech, on both the software and hardware side, to be one of the few sectors that is still talked about as a growth story in this economy.

Certainly the prospects of growth are better in the tech industry than in many other places in the economy, but have investors gotten ahead of themselves? Our team of equity analysts thinks yes. Software and hardware are the only two sectors that our equity analysts think are still overvalued, commanding an 8% and 6% premium to our estimation of fair value.

The most overvalued names are currently companies that operate in areas of the tech market that are some of the most hyped and talked about at the moment--software as a service, health-care IT, and virtualization.

It's not that these aren't areas that are likely to do very well during the coming years; it is that the stock prices have outpaced the potential growth.

Here are a few of the most overvalued names:

We believe Cerner will continue to benefit from the opportunities presented by the U.S. health-care system. The company has capitalized on the urgent need to streamline the system's inner workings and lower operating costs. From its roots as a provider of laboratory information systems, Cerner has evolved into an integrated provider of IT solutions that support all the venues of the health-care realm. However, the complex legal framework that regulates the health-care industry and privacy concerns related to the use of electronic medical records could hamper Cerner.

VMware's success has the IT world focused on virtualization in corporate data centers. Management has laid out its vision to capture the next phase of growth, but we are skeptical that VMware will be able to repeat the dominance it achieved with server virtualization.

Red Hat makes money giving away free software. However, without an economic moat, increased competition threatens to slow Red Hat's impressive growth. The open-source software model leaves Red Hat vulnerable to changes in customer preferences. Open-source software is free for anyone to use and may be distributed and modified at will. Therefore, Red Hat does not own the software it distributes, and any enhancements made by Red Hat are shared with competitors. This leaves Red Hat without a defensible economic moat because the firm's clients have a right to continue using the software even if they switch support vendors. By Jeremy Glaser, Markets Editor for Morningstar.com.

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