Most tech stocks are now trading well below their 2021 highs, but I think only certain types of tech companies are real bargains.
Here’s a look at the types of tech companies that I think present attractive mid- to long-term risk/reward at current levels, and which ones I think are best to hold onto. As always, investors are advised to do their own research before taking any positions.
What I like:
1. Cheap Chip Suppliers with Limited Consumer Hardware Exposure
Shares of companies such as Onsemi (ON), NXP Semiconductors (NXPI) and STMicroelectronics (STM) have soared to levels sporting low double-digit P/Es, although demand remains pretty good seeing them from the heart of a car. and industrial end markets and are poised to benefit from long-term trends such as EV/ADAS adoption and factory automation and IoT hardware investments. While these companies may see some correction in customer inventories, the current market pessimism towards them feels excessive.
Similarly, high-margin fabless chip providers such as Advanced Micro Devices ( AMD ) and Marvell Technology ( MRVL ) have seen their forward P/Es fall to mid-teens levels, though taking share from competitors and hoping to appear strong. Demand from US cloud giants (the proverbial hyperscalers) continues into 2023.
2. Cheap Chip Kit Suppliers with Relatively Low Memory Exposure
Companies such as Applied Materials (AMAT) and KLA (KLAC) now also sport low-double P/Es, although they remain supply-constrained so far and demand has been tipped to remain strong. in 2023.
Although weaker demand is expected from memory makers dealing with large DRAM and NAND flash memory price reductions, this is due to more than offset by strong demand from healthy demand from foundries (contract manufacturers) and manufacturers logic chips make up a solid majority. of sales of companies such as Executive and KLA. In addition, many of these firms are actively buying back stock.
3. Online Ads Play Cheap with Unique Services/Platforms
Thanks in large part to recession fears, companies such as Digital Turbine (APPS) and Perion Network (PERI) have sported preemptive measures on a low-digital front. This is despite the companies long-term benefit from ad dollars moving from offline digital channels and having differentiated solutions in key markets — for example, Digital Turbine’s SingleTap platform to drive rapid app installs on Android devices advance and enable. without having to rely on an app store, or the SORT Perion platform to deliver targeted ads without the need for tracking cookies.
Unless one expects the US to go into a really big recession — and I’m cautiously optimistic that we won’t, given the state of the job market and consumer/corporate balance sheets — such a risk/reward. bodies look good here.
4. Free and Under-Led Small-Cap Growth Stocks
Thanks in part to many growth and momentum investors who have focused most or all of their attention on large caps, many small-cap growth stocks are now available for sale and/or historically low earnings multiples. While not without risk, small-cap growth arguably offers great opportunities to swing the fences right now.
I wrote about some small cap growth stocks I like in late August.
5. Cloud Software Firms with Market Leadership
While I’m wary of some popular cloud software stocks (more on that soon), I think it’s worth looking at companies with market-leading offerings that trade at healthy discounts to the sales and billing multiples they typically sport from 2017 to 2019. Firms like Salesforce.com (CRM), Elastic (ESTC) and Okta (OKTA) come to mind.
Reasons to be cautiously optimistic about these companies (other than their valuations): Cloud software and services spending remains a priority/growth area for many companies, and (although weakness is evident in some regions and industry verticals) earnings reports and conference commentary since large software firms have generally been better than feared in the past few months.
6. 3 of the 5 Tech Giants
Alphabet (GOOGL), Amazon.com (AMZN) and Microsoft (MSFT) all look reasonably priced at these levels, given demand trends and their competitive positions.
Because of recession fears, Alphabet has a GAAP forward P/E of just 17, despite their Google Cloud unit and Other Bets still weighing on the bottom line. Microsoft’s forward GAAP P/E stands at 23 — not exactly dirt-cheap, but quite reasonable given the company’s revenue/bookings growth and the durability of its core software and cloud franchises. And a good case can be made that a strong majority of Amazon’s $1.15 trillion market cap is now covered by AWS, which (based on the FactSet consensus estimate) expects revenue to grow 32% this year to $82.3 billion and is still seeing a backlog. growth comfortably outstrips income growth.
(What about Apple (AAPL) and Meta Platforms (META) ? I think Apple’s long-term story remains intact, but would prefer a larger margin of error than what its stock currently provides, especially given potential macro upside in China and Europe. Meta is pretty cheap, but current trends in user engagement, ad sales and capex look worrisome, as do the huge losses and uncertain payout for Meta’s Reality Labs unit.)
What I don’t like:
1. High-Multiple Cloud Software Stocks
While many cloud software multiples are now quite reasonable, a handful of popular high-growth companies still have sales and billing multiples in the teens or higher. Consider companies such as Cloudflare (NET), Snowflake (SNOW) and Datadog (DDOG) .
Valuations of companies like this are particularly hurt by rising interest rates/Treasury yields, since the lion’s share of future cash flows that investors will be paying for are expected to come for several years. These cash flows must now be discounted at much higher rates than before.
2. Real Profitable/Speculative EV, AV and Clean Energy Plays
Much more than cloud software, which was mostly good companies that were overvalued, the EV/clean energy and autonomous driving/trucking spaces have followed many excesses like the Dot-bubble com to give us. In addition, thanks in part to the recent short showers, many of these eels have not yet been washed away.
Notably, Rivian ( RIVN ), Lucid ( LCID ) and Plug Power ( PLUG ) still have more than $65 billion in combined equity value — and all three still have a ways to go before turning profitable . Autonomous truck plays like Aurora Innovation (AUR) and TuSimple Holdings (TSP) also look very valuable, given their cash flow and all the competition they face, as do some LIDAR providers.
3. Fintechs providing Subprime Lending and/or Operating in Crowded Markets
High interest rates are driving up funding costs for the likes of Klarna’s Affirm (AFRM), Upstart (UPST) and Block’s (SQ) units, just as high inflation weighs on discretionary spending among lower-income consumers who account for some big for them. customer bases.
Looking more broadly at the fintech space, a breakout seems inevitable after years of disruptive funding activity that has resulted in a number of payments and lending areas being swallowed up by competition. Some larger fintechs with strong network effects could weather the storm well, as could some point-of-sale (POS) platform providers that benefit from higher travel/hospitality spending. But things are likely to get messy elsewhere.
4. Most Traditional Enterprise Hardware Providers
Unlike most of the other tech companies I keep an eye on, traditional enterprise hardware providers like HP ( HPQ ), Hewlett-Packard Enterprise ( HPE ) and Dell (DELL). But they also feel like value traps in an environment like this.
Public cloud adoption remains a long-term driver of sales of servers and storage systems entering on-premise enterprise environments, and IT spending surveys have shown pretty consistently that on-prem hardware is one of the first things to see spending cuts to see during macro. downturn. In addition, the delayed ramp for Intel’s ( INTC ) next-generation server CPU platform (Sapphire Rapids) is a near-term headwind for enterprise server sales.
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