NEW YORK (CNN/Money) - Investor disappointment in Oracle's latest quarter may reveal just how vulnerable this year's rally in tech stocks is.
The big database software outfit reported fiscal first-quarter earnings Friday that hit Wall Street's estimates, but revenues came in weaker than expected and Oracle's shares promptly took a dive in early morning trading. For Oracle, the recovery in tech spending so far hasn't been all it's been cracked up to be.
But that the market's faith in Oracle has been so easily shaken is a little surprising. The summer period has always been weak for the company and given the way companies have been shelling out money on PC upgrades and what-have-you, it seems likely that they'll move on to upgrading their systems software. Particularly when you look at the way the economy is cooking.
Yes, Oracle shares should be down. But by 5 percent as they were in before-the bell trading? Such a sharp reaction to incrementally bad news makes it seem like investors were simply expecting too much.
Prices of tech stocks in general suggest that expectations could be too high. Price-to-earnings multiples are astronomical and it is hard to imagine that growth will be enough to justify them.
S&P 500 tech stocks trade at about 42.6 times the past year's earnings. Strip tech out of the S&P 500, and the index trades at 15.5 times earnings. So, is tech's steep valuation justified by the sort of earnings growth the sector is going to see when the economy bounces back? Let's do some math.
Analysts think that tech earnings are going to grow by 43 percent over the next 12 months, but we'll assume that things will really be much better and earnings will increase by 60 percent. That means that tech trades at 26.6 times next year's earnings. Still rich.
Now let's assume that over the following 12 months tech earnings grow another 60 percent. That gives tech a multiple of 16.6 times the earnings it's going to have two years from now. Still more than what the S&P 500 minus tech trades at based on the past year's earnings.
Of course, nobody expects that tech earnings are going to grow by 60 percent for two years in a row. Either tech stocks are incredibly overvalued or the rest of market is incredibly undervalued. Or maybe both are true.