After the parabolic rise in big tech stocks, the question is whether to hold or exit. Strategists at Citi argue that the stock looks more like a sell.
The question comes because Nvidia (Ticker: NVDA), Microsoft (MSFT), Meta Platforms (META), and Alphabet (GOOGL) have seen their shares rise by anywhere from 40% to about 200% this year. That has catapulted the Nasdaq 100 Index up nearly 40%.
For Nvidia, the reason for the surge was expectations that advances in artificial intelligence would boost demand for the company’s semiconductors. Microsoft, an investor in OpenAI, the inventor of ChatGPT, should not only benefit from integrating the technology into its Bing search engine, but also from incorporating AI into its cloud offering, thereby helping to expand the market. On the web, AI improves Google and Meta advertising offers and makes them more attractive to brands.
All of this optimism has boosted valuations — the prices of shares relative to the earnings per share they are projected to deliver in the near future. Investors pay because they expect increasing profits over many years.
Reviews are a key argument for an immediate sale. Barron’s recently argued that tech metrics aren’t that expensive when adjusted for Wall Street’s expected earnings growth. But a look at history and a comparison of technology valuations to those in other sectors reveals a different story.
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Citi compared the forward price-to-earnings ratio of the Nasdaq 100, which FactSet says is a little over 27 times, to about 18 times the S&P 1500, a measure the bank chose because it tracks many stocks covers different sectors. According to Citi, the Nasdaq 100 rarely trades at a significantly higher premium, and when it does, the average move results in a 20% loss over the following year.
Other data suggests that investors are actually overpaying for the tech industry’s earnings growth potential. For many technology companies in the S&P 1500, EPS growth is expected to exceed growth in the broader index by about three to six percentage points. However, the valuations of some of these stocks are far higher than those of the index.
Premiums vary, but one group of companies has traded an average multiple of five points higher than the S&P 1500 over the past five years, while valuations for a second group have traded about 10 points higher. These are big gaps: the premiums have averaged only one to three points over the past 20 years.
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That’s not to say the tech industry is necessarily in a bubble, or that these stocks are absolutely certain to experience the double-digit declines they’ve seen in the past. Earnings growth could potentially boost stock prices over the years if investors remain willing to pay now for future earnings.
And there is one case where they will. AI seems real, as evidenced by Nvidia’s revenue forecast, which beat analysts’ estimates last quarter. Brian Macauley, a portfolio manager at Broad Run Investments, said he’s targeting multi-year earnings growth for Alphabet, a company stock.
The real point is that there’s a chance the technology will stumble or it won’t be able to sustain its current performance. Other opportunities in the market may be looking better, such as economically sensitive non-tech stocks that are well positioned to thrive if the Fed eventually stops raising rates, allowing demand for goods and services to pick up.
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“Selling technology” is by no means a crazy idea.
Write to Jacob Sonenshine at [email protected]