With chasing, call-buying, short-covering having driven a lot of crazy market action in the face of stubbornly high inflation and a hawkish Fed, and with SVB Financial's (SIVB) meltdown introducing a fresh dose of uncertainty for unprofitable tech companies that might eventually need additional funding, being patient and selective could do tech-stock investors a lot of good.
Here are a few suggestions for those willing to brave the waters and make fresh stock buys in this environment.
1. Consider Waiting for Moments of Elevated Fear to Buy
January and February's market action has shown that a lot of investors really have trouble giving up on the kinds of speculation and valuation-indifferent chasing that often panned out during the 2020/2021 bubble.
Though such action likely hit its apex in early February, there was still a lot of it to go around until the last several days. This can be seen in how many high-multiple growth stocks were often chased higher following even modestly better-than-expected earnings reports, as well as in the explosive growth of zero days to expiry (0DTE) call-buying, which can feed on itself for a while as options dealers hedge their call sales by buying shares in the underlying security.
But as Thursday and Friday's selloff -- as well as a slew of other selloffs over the last two years -- demonstrated, those chasing stocks out of FOMO are prone to become panic-sellers once markets see a significant move lower. And when the speculative flows that have helped fuel big upside moves disappear or reverse course, things can get ugly in a hurry.
For these reasons, waiting for the market to flash signs of elevated fear -- if not outright panic -- before making large buys could serve investors well. Though time will tell how long it lasts, we arguably got such a high-fear/panic environment in parts of the market on Friday.
2. Stay Sensitive to Valuations
After accounting for higher interest rates, which require a higher discount rate to be applied to a company's expected future cash flows, U.S. stocks collectively still don't look all that cheap. Indeed, the equity risk premium -- a measure that attempts to calculate the additional return an investor can expect for owning stocks (and taking on the risks involved) relative to owning 10-year Treasuries -- is near a 20-year low.
And with higher rates particularly a negative for the shares of firms whose valuations depend heavily on cash flows expected several years from now and later (since such cash flows now have to be discounted much more significantly), there's more reason to be partial to companies trading at low or moderate multiples of expected near-term earnings and free cash flow (FCF).
And when it comes to tech companies that for now generate few or no profits, I think it makes sense to opt for names whose sales/billings multiples provide some margin of error and whose cost structures give them a clear path to producing significant profits within a few years' time. Particularly with SVB Financial's collapse potentially yielding a tougher capital-raising environment for money-losing tech firms.
3. Look for Quality, Profitable Firms Whose Shares Have Been Pressured By Recession Fears
In 2022, many highly profitable firms (both in tech and elsewhere) saw their shares battered due to fears that Fed tightening would quickly trigger a big recession, replete with tumbling consumer spending and a large spike in unemployment. And while the shares of these companies have often rallied over the last couple of months, their valuations often still don't look that stretched, particularly given that a lot of recent economic data doesn't point to a recession arriving soon.
Within tech, I think a slew of chip and Internet companies, such as STMicroelectronics (STM) , Applied Materials (AMAT) , Alphabet (GOOGL) and PayPal (PYPL) , fit this description. Should tech stocks start seeing genuine panic-selling thanks to Fed/inflation concerns, some good deals are likely to emerge among such names, whose valuations and business models could help them outperform in an environment featuring high inflation and a stronger-than-feared economy.
4. Look for Companies With Levers for Unlocking Shareholder Value
Some of the best-performing tech stocks this year have been beaten-up names that faced some clear business headwinds and whose decision-making had often been questioned in 2022, but which also had some levers to pull for unlocking value (e.g. spending cuts, stock buybacks, price hikes, asset sales). Think firms such as Meta Platforms (META) , Salesforce (CRM) , Twilio (TWLO) and Sea Limited (SE) .
As more tech companies come to grips with the fact that the growth-at-all-costs era is over and probably won't be back for a while, we should see more of them reward shareholders by making decisions that they wouldn't have been willing to make a short while ago. In addition, some small-cap and mid-cap tech companies that were previously reluctant to agree to a sale -- or which set very high sale prices -- might now be more willing to engage potential suitors.
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