Tech stocks have delivered incredible returns over the last decade. However, there has been a chorus of analysts and experts warning us that they were overvalued during this run. As ever, things are a little more complex. Is there data to support the view that technology stocks aren’t overvalued?
Upward Trend in Tech
The pandemic accelerated the upwards trend for tech. As remote working became the norm, cloud-based SaaS, cyber security, and eCommerce demands grew sharply. While skeptics suggest the reopening of offices will signal a downturn for tech stocks, they might not be factoring in the government’s $2trillion digital transformation aimed at consumers and enterprise. These programs represent a fantastic opportunity for tech companies.
Indeed, one of the more exciting beneficiaries of this development program could be AT&T AT&T. The telecoms giant has been down 20% over the last three years after attempting to transform itself into a media conglomerate. But a pivot back towards its core telecoms business is happening. By 2023, it’s projected to have an annual free cash flow of $20 billion. AT&T is currently valued at $180 billion, so that’s only x9 of the projected cash flow. If anything, AT&T looks undervalued.
One of the risks with pure technology stocks that isn’t talked about enough is the impact of future innovations. Tech stocks that are sitting pretty now could be disrupted by tech advances that no one sees coming.
BofA Global Research showed that 40% of fund managers said that tech was the most crowded trade over recent months. Indeed, tech stocks — and adjacent tech stocks like Alphabet, Amazon, Facebook, and Netflix — account for almost 40% of the S&P 500’s weight.
Additionally, valuations are trading at 26 times forward their 12-month earnings, which is significantly higher than the X20 of the rest of the S&P 500. As retail investors continue to pile into these stocks, at some point, these forward earnings could lose touch with reality.
Stocks To Watch Out For
Adam Parker’s Centre Lake Capital suggests Adobe is one tech stock to watch out for. Their subscription model brought in $13 billion in 2020. They have a suite of photo and video editing tools that constantly push the boundaries of home and enterprise use.
Parts and components for computers have had a challenging year. COVID-19 related shipping problems have disrupted business significantly. However, there are a few innovative factors manufacturing companies whose price looks good compared to future earnings.
Micron makes memory semiconductor chips. The stock peaked at around $90 in April but is now down to around $70. Demand is high; the company is profitable. Once shipping returns, it could go past $100.
What To Watch Out For
Of course, the tech boom frequently draws parallels with the dot-com boom of the late 90s. Tech innovation and green energy ETFs are heavy, with firms currently losing money but having high valuations. Some analysts suggest history will repeat itself when these stocks don’t live up to expectations.
Another issue to beware of is bond prices. Last month, a sharp rise in Treasury yields sent shockwaves throughout the market. As the Fed tempers its asset purchases and inflation grows, it could mean bad news for tech stocks’ future earnings.
But the picture isn’t entirely bleak. With Alphabet, Apple, and Facebook expected to post 30% increases in revenue, that should be enough to keep the train rolling no matter what happens with bonds.
Hedge fund favorite Match Group, Inc holds over 45 internet dating sites, like Match, Tinder, OK Cupid, and so on. They have more than 50% market share in an industry growing steadily over the last two decades. Post-COVID, they are expected to aggressively target the 600m + global singles.
On the more pessimistic side, Ark Innovation sat at $158 in February. It’s now down to $124. The FAANGs have had a rocky ride since mid-September, and Zoom has lost 50% of its share price. Amazon still looks like a good pick because of its move into other areas, like cloud computing. Currently hovering below $3500, RBC Capital recently rated it as around $4,100.
But what about the new FAANGs? Are there companies that could deliver returns? Two great picks are Spotify and Uber, according to legendary investor Mark Mahaney. Spotify, because of its good market share and customer retention. Uber, for its resilience throughout COVID and its room to push up prices.
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Alpesh Patel OBE