Big Tech stocks have finally stumbled. For longer-term investors, they look like complete buys.
Apple (ticker: AAPL), Microsoft (MSFT), Amazon.com (AMZN), Nvidia (NVDA) and Tesla (TSLA) are between 9% and 14% below their 2023 highs after posting double-digit gains throughout the year recorded in the first seven months of the year. Alphabet (GOOGL) and Meta Platforms (META) were less affected, falling 3% and 6%, respectively.
Nothing goes up forever, and there are many reasons for the declines, from stretched valuations to the extent of their popularity to the rise in the 10-year Treasury yield, which rose to as high as 4.8% last week Value since 2007, based on a summer low of around 3.7%.
Enter the bull case. It starts with the fact that the rise in yields is likely to slow down from here. They simply cannot continue to rise at the same pace, especially since they already reflect the Federal Reserve’s plan to keep interest rates higher for longer. A decline in yields would, of course, give a boost to tech stocks – and the entire stock market, for that matter – but even just a slower rise would be helpful.
Additionally, according to Goldman Sachs, this group of seven technology stocks is expected to outperform the other 493 S&P 500 stocks by two to three percentage points if the 10-year yield stays flat over the next two months and increases by half a percentage point the way, how tech stocks and returns correlate historically.
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That depends on the result. According to FactSet, the group’s net profit is expected to rise about 20% in 2024, with profit forecasts rising since late March as analysts have become familiar with the reality of artificial intelligence.
In addition, the shares are significantly cheaper than they were just a few months ago. The seven companies now trade at a combined 27x 2024 earnings estimates, up from 34x at this year’s peak. Yes, that’s more expensive than the S&P 500, but given the stocks’ expected earnings growth, that’s not a compelling valuation.
This is all reflected in the company’s PEG ratio – its price-to-earnings ratio divided by its earnings growth. Overall, group analysts expect long-term annual earnings per share growth of approximately 20.7%. Next year’s 27x EPS represents about 1.3x that growth, below the average 1.9x PEG ratio of the other 493 S&P 500 stocks.
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In other words, investors pay less for each percentage point of Big Tech’s earnings growth than for the same growth in the rest of the market.
Microsoft is a good example. It trades at 28.2 times earnings. And with analysts expecting 16.2% annual EPS growth over the next three years, the stock’s PEG ratio is about 1.7x.
For the cloud giant, it’s all about revenue growth and artificial intelligence. Revenue is expected to grow nearly 16% annually over the next three years to about $344 billion in 2026. The strongest growth would come from Microsoft’s prominent cloud product Azure, which is now augmented with artificial intelligence capabilities. It is this type of product improvement that helps the company increase subscription prices and gain market share. Sales growth will not be possible without rising research, development and marketing costs, which will prevent rapid growth in profit margins, but profit growth is expected to remain high.
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You don’t need artificial intelligence to know that Big Tech is a buy.
Write to Jacob Sonenshine at [email protected]