After the parabolic run of Big Tech stocks, the debate is now whether to hold them or fold them. Strategists at
argue that stocks are more like sales.
The question arises because
(GOOGL) have seen their shares soar between 40% and around 200% this year. This catapulted the
Index to a gain of nearly 40%.
For Nvidia, the surge was fueled by expectations that advances in artificial intelligence will increase demand for the company’s semiconductors. Microsoft, an investor in OpenAI, the creator of ChatGPT, stands to benefit not only from integrating the technology into its Bing search engine, but also from overlaying AI into its cloud offering, helping to expand its market . For the Internet, AI improves Google and Meta advertising offerings, making them more attractive to brands.
All of this optimism has driven up valuations, that is, stock prices relative to the earnings per share they are expected to generate in the near term. Investors pay because they expect profits to grow for many years.
Ratings are a key part of the selling point now. Barrons recently argued that tech multiples aren’t that expensive when adjusted for the earnings growth expected by Wall Street. But a look at history and a comparison of technology valuations with those of other sectors tells a different story.
Citi compared the forward price-to-earnings ratio for the Nasdaq 100, at just over 27 times, according to FactSet, with around 18 times for the S&P 1500, a metric the bank chose because it encompasses many stocks across all sectors. The Nasdaq 100 rarely trades at a much higher premium than that, according to Citi, and when it does, the average move the following year is a 20% loss.
Other data implies that investors are indeed paying too much for the technology’s earnings growth potential. Many technology groups within the S&P 1500 are expected to see EPS growth outpace broader index growth by about three to six percentage points. But the valuations of some of these stocks are much higher than those of the index.
Premiums vary, but one group of companies has traded on average five points higher than the S&P 1500 over the past five years, while a second group’s valuations have been around 10 points higher. These are big gaps: premiums have averaged only one to three points over the past 20 years.
That’s not to say that tech is necessarily in a bubble, or that these stocks are absolutely certain to see the double-digit declines they’ve faced in the past. Earnings growth could potentially push stock prices higher over the years if investors remain willing to pay now for future earnings.
And there is a case where they will. AI appears to be real, as shown by how Nvidia’s sales forecast beat analysts’ estimates in its most recent quarter. Brian Macauley, portfolio manager at Broad Run Investments, said he sees many years of earnings growth at Alphabet, a stock owned by the company.
The real point is that the technology may stumble or may not be able to maintain its recent performance. Other opportunities in the market might look better, such as economically sensitive stocks outside of technology, which are positioned to thrive as the Fed eventually stops raising rates, allowing demand for goods and services to take off.
“Selling technology” is not a far-fetched idea.
Write to Jacob Sonenshine at firstname.lastname@example.org