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  1. Home
  2. / Investing
  3. / Technology

Tech Investors Should Consider Moderately-Valued Growers During a Correction

While some growth stocks have been bid up to extreme valuations, others could look intriguing if markets see a meaningful downturn.
By ERIC JHONSA
Jun 25, 2020 | 06:30 AM EDT
Stocks quotes in this article: SHOP, FSLY, DDOG, ZS, TEAM, AVGO, AMAT, HPQ, EBAY, STX, NLOK, TSM, NXPI, LRCX, PINS, DBX, IAC

Should tech stocks see the kind of major correction that has felt overdue in recent weeks, there's a case for taking a Goldilocks approach to making new stock buys.

Which is to say, an approach that avoids going after both recent high-flyers that have been bid up to nosebleed valuations and dirt-cheap tech companies that are contending with serious macro and/or company-specific headwinds, but instead zeroes in on growing companies that investors haven't aggressively crowded into since March.

One caveat here: Given how hard it is to predict just how much of an impact COVID-19 will directly and indirectly have on economic activity over the next 12 to 18 months, analyst estimates for any period outside of the very short-term need to be taken with a grain of salt. Depending on how macro conditions trend, those estimates could look very different in a few months' time.

With that said, there are quite a few enterprise software and Internet names that would look richly-valued even if one boosted consensus estimates by 20% or so. Right now, there are more than 20 U.S.-traded software and Internet firms with $1 billion-plus market caps that sport enterprise values (EVs) equal to more than 15 times the consensus sales estimate for their next fiscal year (forward EPS and free cash flow multiples, in those cases where the company is profitable and cash-flow positive, are much higher still).

A number of high-flyers are also above 20x -- the list includes names such as Shopify (SHOP) (35x), Datadog  (DDOG) (34x), Fastly (FSLY) (21x), Zscaler  (ZS) (25x) and Atlassian  (TEAM) (22x). Even if one is quite confident that these companies will keep executing well and won't be badly stung by macro headwinds, the long-term risk/reward doesn't look especially good at current levels for most of these names.

On the other end of the ledger, you have the 40 or so $1 billion-plus, U.S.-traded, tech companies that still have forward P/Es under 15. There are a few names here that might be worth picking up during a market downturn -- for example, Broadcom  (AVGO) (13x) and Applied Materials (AMAT)  (14x). But there are also a lot of names -- for example, HP  (HPQ) , eBay (EBAY) , Seagate  (STX) and NortonLifeLock (NLOK) -- that either look like value traps or appear fairly valued given their competitive positions, macro vulnerability and/or lack of major secular growth drivers.

In between these two extremes, you can find a lot of tech companies that have healthy competitive positions and meaningful long-term growth drivers, and which have valuations that -- though in some cases a little steep right now -- are by no means in nosebleed territory.

Chip industry firms such as Taiwan Semiconductor (TSM) , NXP Semiconductors (NXPI) and Lam Research (LRCX) , which respectively have forward P/Es of 19x, 17x and 17x, arguably fit this description. So do some Internet and software companies that sport high gross margins and have subdued forward sales and/or FCF multiples, such as Pinterest (PINS) , Dropbox (DBX) and InterActiveCorp (IAC) .

Readers might have a different set of names that they feel most accurately fit this description. But either way, at a time when legions of retail investors and hedge funds have crowded into select high-growth tech companies with nary a concern for either multiples or the potential growth headwinds, those looking to jump in if and when the Nasdaq has a healthy pullback might want to focus on growth companies whose valuations provide a measure of protection against continued macro weakness.

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At the time of publication, Action Alerts PLUS, which Jim Cramer co-manages as a charitable trust, was long AVGO.

TAGS: Investing | Technology

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