It has been an ugly month for the technology sector.
The Nasdaq is on pace for its worst month since October 2008. Sentiment for the sector has turned negative, and dip buyers have been elusive. Fears of slowing growth, higher interest rates, uncertainty about supply chains and geopolitical events have weighed on the broader market, but tech has carried the brunt of the pain. In April, the Nasdaq entered bear market territory (a decline of 20% or more).
It’s situations like this that remind me of one of Warren Buffett’s famous quotes: Be fearful when others are greedy, and greedy when others are fearful.
Given the selloff in the once highflying growth sector, parts of the sector have become oversold and now carry much lower valuations. People seem to have given up on tech stocks — even the big-cap tech names that continue to produce strong free cash flow and engage in shareholder accretive activities like stock buybacks. In some respects, tech is looking more like a value sector than a growth sector.
Despite the growing belief that tech is “un-investable,” there’s some evidence to the contrary. However, not all tech is created equal.
What has changed?
Tech was once the darling of the market. These stocks led the market out of the pandemic-fueled bear market, as they were viewed as defensive plays that would weather the economic slowdown better than other parts of the market. Now, with a growing belief that we are heading for a slowdown in growth, tech has been less resilient.
Many of the big tech names in the S&P 500 (sans Apple) reached technical “bear market territory” off their all-time highs. Moreover, the worst performing Dow stock this year is also a tech company: Salesforce.com. Smaller, typically more speculative growth equities have seen much greater selling pressure over a longer timeframe. In sum, the whole tech complex is under pressure.
The good news is that valuations have come down in a big way. The next step is to determine if the fundamental outlook has changed for these companies. There’s no doubt that a slower economy might ding profit growth, but history has shown that it’s often during times of uncertainty and sluggish GDP — Q1 GDP released this week, showing a decline of 1.4% — is when pockets of quality growth stocks perform well.
Also keep in mind that, thus far, despite a couple surprising misses, earnings growth for Q1 has been better than expected for the tech sector. As things currently stand, the group has the best sales beat rate (meaning the number of companies in the sector beating their consensus estimates) and second-best earnings beat rate for Q1. Additionally, 2022 earnings growth has been steady near 8% for the tech sector over the past two months. Sales estimates have also held firm at about 10% for 2022. Despite all the fears of a growth slowdown, it’s not showing up in the numbers for tech stocks.
Large-cap technology valuations turn more attractive.
The valuation of tech has reset lower given the selloff, making some stocks look more attractive, especially as earnings growth holds its own. The tech sector’s forward price-to-earnings (P/E) ratio has dropped back to about 22x, a significant move lower from near 30x a few months ago. For perspective, a low-20x sector P/E is about on par with pre-COVID rates. Consumer Discretionary, dominated by Amazon and Tesla, has also turned less pricey. That sector’s forward P/E was above 40x in late 2020 but is now barely above 26x.
For the FAANGM stocks (that’s Facebook, Apple, Amazon, Netflix, Google and Microsoft), valuations have also been reduced. On average, the P/Es for this group are 25% lower than their five-year average. It has been rare to find these stocks at this type of discount in the past.
Separating quality and speculation in tech land
We cannot group all tech companies together, however. Cash flow-producing market leaders have separated themselves from speculative non-earners. Investors should tread carefully when looking to scoop up severely beaten down innovators that were the hot plays coming out of the pandemic. It can be tempting to buy shares in stocks that are down 70%+, but the dotcom bust taught us those broken names can go years without seeing meaningful bounces.
We believe it’s best to stick with high-quality, high-conviction tech stocks in this environment. Volatility continues to be high, and momentum is awful for small- and mid-cap growth companies. Large-cap tech-related firms continue to prove themselves as free cash flow marvels with a war chest of cash for share buybacks. The big names have also turned much cheaper. Even as the Nasdaq hits bear market territory, sticking with a strategy of owning good companies with reasonable valuations should reap rewards for long-term investors.
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Lindsey Bell, Ally’s chief markets & money strategist, is an award-winning investment professional with a passion for personal finance and more than 17 years of Wall Street experience. Bell’s unique ability to connect the dots between data and real life and craft bite-sized money ideas that people can use and apply stems from her deep background as an analyst, researcher and portfolio manager at organizations including J.P. Morgan and Deutsche Bank. She is known for demonstrating why and how an understanding of all things money improves a person’s finances and overall well-being. An ongoing CNBC contributor, Bell empowers consumers and investors across all walks of life and frequently shares her insights with the Wall Street Journal, Barron’s, Kiplinger’s, Forbes and Business Insider. She also serves on the board of Better Investing, a non-profit focused on investment education.