(11/08/13) Beware of Bubbles

The lesson of history is this: Bubbles eventually pop! In 2000, investors felt the nasty sting of that fall, both seasonally and directionally, for a decade or more, recalls Jim Oberweis, Jr. in The Oberweis Report.

Victims of the late 1990s tech boom neglected basic laws of intelligent investing and replaced them with nonsensical metaphors to justify greed, like profits don't matter.

Now, as the stock market soars, isolated strains of valuation amnesia have been reported once again. And among a few momentum stocks, the possibility of massive overvaluation is more than plausible.

Bubbles usually start around real ideas, often ideas with dreamlike investment potential. In the 1840s, it was railroads. In the 1920s, we had radio, automobiles, aviation, and electric power grids. In the 1980s, it was anything Japanese.

By the late 1990s, internet and e-commerce stock valuations rocketed into the stratosphere. While a few of the highly-touted bubble stocks grew into big winners, most bombed.

These days, the bubble is more narrowly focused—battery-powered cars, 3D printers, and software-as-service stocks.

Conceptually, we love all three. What could be better than a car that uses no gas and has Ferrari-like pickup? We love the idea behind Tesla (TSLA); we love the industry and love the product, but can't help but wonder if 100 times earnings might be a wee bit frothy for a car maker.

Similarly, there's little doubt that 3D printers have the potential to change the world. Still, it's far from obvious which companies will be massively profitable as a result.

We expect commoditization of 3D printing (which implies meager future margins), and wonder with amazement at the valuation of Exone (XONE), trading at 114 times estimated earnings in 2014.

In software-as-a-service, take your pick of silliness: Customer relationship manager software firm Salesforce.com (CRM) trades at 104 times estimated 2014 earnings, or human capital management software vendor Workday (WDAY) boasts a P/E of infinity because it earns nothing and isn't expected to be profitable for at least the next couple of years.

Another sign of excess is online real-estate information firm Zillow (Z). Like most bubble firms, Zillow is exceptionally well-managed, growing quickly, and has a fantastic market position with a disruptive product. It just isn't worth 240 times forward estimated earnings.

Thanks in large sum to the Fed, the spigot is on for the stock market, but risks are beginning to rise. Valuations for high-growth stocks are no longer below average. Pockets of excess—although not yet widespread—are clearly popping up.

Rational stock pickers—people who buy great businesses at reasonable prices—seem likely to beat those chasing the latest hot thing. Be careful of glamour stocks like TSLA, CRM, WDAY, Z, and XONE.