Most tech stocks now trade way below their 2021 highs, but I think only certain kinds of tech companies are truly bargains.
Here's a bird's-eye view of the kinds of tech companies I think present attractive medium-to-long-term risk/rewards at current levels, and which ones I think it's best to steer clear of. As always, investors are advised to do their own research before taking any positions.
What I Like:
1. Cheap Chip Suppliers with Limited Consumer Hardware Exposure
Shares of companies such as Onsemi (ON) , NXP Semiconductors (NXPI) and STMicroelectronics (STM) have plunged to levels that leave them sporting low-double-digit P/Es, even though they're still seeing pretty good demand from core auto and industrial end-markets and are poised to benefit from long-term trends such as EV/ADAS adoption and factory automation and IoT hardware investments. Though these companies might see some customer inventory corrections, the market's current pessimism towards them feels excessive.
Likewise, high-margin fabless chip suppliers such as Advanced Micro Devices (AMD) and Marvell Technology (MRVL) have seen their forward P/Es fall to mid-teens levels, even though they're taking share from rivals and expect to see strong demand from U.S. cloud giants (the proverbial hyperscalers) continue into 2023.
2. Cheap Chip Equipment Suppliers with Relatively Low Memory Exposure
Companies such as Applied Materials (AMAT) and KLA (KLAC) now also sport low-double-digit P/Es, even though they remain supply-constrained for now and have signaled that demand will remain strong in 2023.
While weaker demand is expected from memory makers dealing with large DRAM and NAND flash memory price declines, this is due to be more than offset by strong demand from healthy demand from the foundries (contract manufacturers) and logic chip manufacturers that make up a solid majority of the sales of companies such as Applied and KLA. Moreover, a lot of these firms are aggressively buying back their stock.
3. Cheap Online Ad Plays with Unique Services/Platforms
Thanks in large part to recession fears, companies such as Digital Turbine (APPS) and Perion Network (PERI) sport low-double-digit forward P/Es. This is in spite of the fact that the companies benefit long-term from ad dollars moving from offline to digital channels and have differentiated solutions in key markets -- for example, Digital Turbine's SingleTap platform for promoting and enabling quick installs of apps on Android devices without needing to rely on an app store, or Perion's SORT platform for delivering targeted ads without the need for tracking cookies.
If one doesn't expect the U.S. to go into a truly major recession -- and I'm cautiously optimistic that we won't, given the state of the job market and consumer/corporate balance sheets -- the risk/rewards for such companies look pretty good here.
4. Cheap and Underfollowed Small-Cap Growth Stocks
Thanks in part to many growth and momentum investors directing most or all of their attention to large-caps, quite a few small-cap growth stocks are now available for historically low sales and/or earnings multiples. Though not without risk, small-cap growth arguably presents some great opportunities to swing for the fences right now.
I wrote about a few small-cap growth stocks that I like in late August.
5. Beaten-Up Cloud Software Firms with Market-Leading Products
While I'm wary of some popular cloud software stocks (more on that shortly), I think companies with market-leading offerings that trade at healthy discounts to the sales and billings multiples they typically sported from 2017 to 2019 are worth a look. Firms such as Salesforce.com (CRM) , Elastic (ESTC) and Okta (OKTA) come to mind.
Reasons to be cautiously optimistic about these companies (aside from their valuations): Cloud software and services spend remains a priority/growth area for many companies, and (though weakness has been seen in some regions and industry verticals) earnings reports and conference commentary from major software firms has generally been better than feared over the last couple of months.
6. 3 of the 5 Tech Giants
Due to recession fears, Alphabet has a GAAP forward P/E of just 17, in spite of its Google Cloud and Other Bets units still weighing meaningfully on its bottom line. Microsoft's GAAP forward P/E stands at 23 -- not exactly dirt-cheap, but pretty reasonable given the company's revenue/bookings growth and the durability of its core software and cloud franchises. And one can make a good case that a solid majority of Amazon's $1.15 trillion market cap is now covered by AWS, which (based on the consensus FactSet estimate) is expected to see revenue grow 32% this year to $82.3 billion and is still seeing backlog growth comfortably exceed revenue growth.
(What about Apple (AAPL) and Meta Platforms (META) ? I think Apple's long-term story is still intact, but would prefer a larger margin of error than what its stock currently provides, particularly given potential macro headwinds in China and Europe. Meta is quite cheap, but current user-engagement, ad-sales and capex trends look worrisome, as do the huge losses and uncertain payoff for Meta's Reality Labs unit.)
What I Don't Like:
1. High-Multiple Cloud Software Stocks
Though many cloud software multiples are now pretty reasonable, a handful of popular high-growth companies still have forward sales and billings multiples in the teens or higher. Think companies such as Cloudflare (NET) , Snowflake (SNOW) and Datadog (DDOG) .
Soaring interest rates/Treasury yields especially hurt the valuations of companies like these, since the lion's share of the future cash flows that investors are paying for are expected to arrive a number of years down the line. These cash flows now have to be discounted at much higher rates than they previously needed to be.
2. Highly Unprofitable/Speculative EV, AV and Clean Energy Plays
Far more than cloud software, which to a large extent featured good companies that just got overvalued, the EV/clean energy and autonomous driving/trucking spaces have given us quite a lot of Dot-com bubble-like excess. Moreover, thanks in part to recent short-squeezes, a lot of this froth still hasn't been washed out.
Remarkably, Rivian (RIVN) , Lucid (LCID) and Plug Power (PLUG) -- all three of which still have a ways to go before they turn profitable -- still have more than $65 billion in combined equity value. Autonomous trucking plays such as Aurora Innovation (AUR) and TuSimple Holdings (TSP) also still look pretty richly-valued given their cash burn and all the competition they face, as do some LIDAR suppliers.
3. Fintechs Doing Subprime Lending and/or Operating in Crowded Markets
High interest rates are raising funding costs for the likes of Affirm (AFRM) , Upstart (UPST) and Block's (SQ) Klarna unit, just as high inflation weighs on discretionary spending among the lower-income consumers that account for a large portion of their customer bases.
And looking more broadly at the fintech space, a shakeout appears inevitable following years of breakneck funding activity that's led to a number of payments and lending fields being swamped with competition. Some larger fintechs with strong network effects might weather the storm well, as might some point-of-sale (POS) platform providers that benefit from higher travel/hospitality spending. But things are likely to get messy elsewhere.
4. Most Traditional Enterprise Hardware Suppliers
Unlike most of the other tech companies I'm wary of, traditional enterprise hardware suppliers such as HP (HPQ) , Hewlett-Packard Enterprise (HPE) and Dell (DELL) generally sport low P/Es. But they also feel like value traps in an environment like this.Public cloud adoption remains a long-term headwind for sales of servers and storage systems going into on-premise enterprise environments, and IT spending surveys have pretty consistently shown that on-prem hardware is one of the first things to see spending cuts during a macro downturn. In addition, the delayed ramp of Intel's ( INTC) next-gen server CPU platform (Sapphire Rapids) stands to be a near-term headwind for enterprise server sales.