Needless to say, tech investors often have to pay pretty rich multiples right now to own a piece of favored tech giants and high-growth software and Internet names.
But if one looks off the beaten path -- which is to say, away from the companies and industries that growth and momentum investors have crowded into over the last few months -- one can still arguably find some decent companies sporting reasonable valuations.
There are three caveats here:
- Cheap stocks are often cheap for a reason. While there's a good case in an environment like this one for combing the bargain bin for values as opposed to paying top dollar for showroom items, one still needs to be selective while doing so.
- Given how correlated tech stock movements often are, a major selloff in more richly-valued names probably won't leave cheaper stocks unscathed, though they might register smaller declines.
- Investors should definitely do their own research before buying any of the names that are mentioned below.
With that out of the way, here are three areas where one can find growing companies whose multiples haven't skyrocketed.
1. Chip Equipment Makers
Valuations - With a few exceptions, chip equipment stocks haven't registered massive gains this year, after having bounced sharply from their late-2018 lows in 2019. Names such as Applied Materials (AMAT) , KLA (KLAC) and Lam Research (LRCX) still carry forward P/Es (based on their next fiscal years) in the teens, and Ichor (ICHR) and Ultra Clean Holdings (UCTT) are even cheaper.
The Bull Case - Global chip consumption continues to steadily grow, and there's a long-term trend towards greater capital-intensity for cutting-edge logic and memory manufacturing processes. Taiwan Semiconductor is still investing heavily in capex, and memory makers are starting to dial up their capex after cutting it sharply last year. Also, orders from Chinese chip manufacturers have been rising sharply.
Risks - Memory demand and prices have been softening a bit lately, and that just might affect the capex plans of some memory makers. Also, in light of both the extensive sanctions placed on Huawei and new restrictions on tech exports to China that could have military uses, there's a risk that some of the chip equipment exports to China that are currently allowed could eventually be blocked.
2. Software Vendors Likely to See Moderate Growth
Valuations - There's a middle ground to be found between high-growth SaaS firms that have been bid up to nosebleed valuations (e.g. Zoom, Coupa Software, Okta, etc.) and age-old, share-losing software vendors with understandably low P/Es (Oracle, IBM, etc.). Cloud business intelligence software vendor Domo (DOMO) has a forward EV/sales ratio of around 5, while hyperconverged infrastructure software vendor Nutanix (NTNX) has one around 3. IT management software vendor SolarWinds (SWI) has a forward EV/FCF ratio of around 18, while Dropbox (DBX) has one of just 15.
The Bull Case - Specific growth drivers vary from company to company, although software's steady growth as a percentage of global IT spend is more broadly a tailwind. Domo benefits from growing corporate BI/analytics investments, while Nutanix benefits from rising adoption of hyperconverged infrastructures on account of their scalability and ease of management. Dropbox continues seeing healthy demand among individuals and SMBs for its cloud storage and collaboration offerings.
Risks - Businesses seeing top-line pressures thanks to COVID-19 are often paring back their IT spend, and that's particularly a headwind right now for tech companies that get much of their revenue from on-premise enterprise (as opposed to cloud) deployments, such as SolarWinds and Nutanix. Also, all of the aforementioned companies face competition from larger tech companies.
3. Chinese Tech Stocks
Valuations - Though some Chinese tech stocks have registered big gains this year, their valuations are still often meaningfully lower than those of American peers with comparable growth profiles. Fast-growing e-commerce software/services provider Baozun (BZUN) has a forward P/E of 22, and Tencent-controlled game-streaming leader Huya HUYA has a forward EV/sales ratio of 2. And though (like Amazon) it's clearly not being run with the goal of maximizing short-term profits, Alibaba (BABA) still only has a forward P/E of 23.
The Bull Case - China's economy has been rebounding well after slumping earlier this year thanks to COVID. Long-term, continued middle class/disposable income growth and well-evolved Internet and mobile ecosystems should remain tailwinds.
Risks - Trade and geopolitical tensions are clear wild cards here, as is the possibility that new accounting rules could lead many Chinese companies to be delisted from U.S. exchanges. Also, accounting concerns are still very much around in the wake of the Luckin Coffee scandal.
