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  1. Home
  2. / Investing
  3. / Technology

The Tech Sector's Valuation Gap Is Narrowing -- And That's Probably a Good Thing

Many tech stocks sporting high valuations have been selling off in recent weeks, even as the rest of the sector generally holds up well.
By ERIC JHONSA
Oct 19, 2019 Updated Oct 20, 2019 | 04:26 PM EDT
Stocks quotes in this article: ZEN, AAPL, DDOG, WORK, CRWD, AYX, NFLX, MTCH, SWKS, HPE, CIEN, ANGI

The Nasdaq fell just 0.5% on Friday, but the day felt a lot worse than that if one's attention was focused on the performance of more richly-valued tech names.

By my count, more than three dozen tech companies with market caps above $1 billion fell 4% or more on Friday, as did a slew of others with market caps between $100 million and $1 billion. And though there were a few tech names with subdued valuations among the decliners, the lion's share -- particularly among the ones worth more than $1 billion -- consist of high-multiple names.

Enterprise software firms were particularly well-represented: Datadog (DDOG) , Slack Technologies (WORK) , CrowdStrike (CRWD) , Alteryx (AYX) and Zendesk (ZEN)  all registered 5%-plus declines. Other big decliners included Shopify, Wayfair, Roku (had rallied strongly over the last two weeks), Match Group (MTCH) and (as markets continued digesting its Q3 results and Q4 guidance) Netflix (NFLX) .

Likewise, in a decline that highlights how Wall Street is becoming more demanding of high-multiple names, collaboration software giant Atlassian fell 4.7% after posting a decent earnings report on Thursday afternoon. Atlassian comfortably beat its September quarter revenue, EPS and billings estimates, and (though leaving EPS and free cash flow guidance unchanged) moderately hiked its fiscal 2020 (ends in June 2020) revenue guidance. Markets apparently wanted more from a company that went into earnings trading for about 17 times its expected fiscal 2020 billings.

Meanwhile, a scan of the $1 billion-plus tech companies that finished higher on Friday turns up many names carrying moderate valuations. Apple (AAPL) made the cut, as did the likes of Ciena (CIEN) , HP Enterprise (HPE) , Fabrinet, Skyworks (SWKS)  and ANGI Homeservices (ANGI) .

If one looks at the tech stocks registering the biggest losses over the first 18 days of October -- a time during which the Nasdaq has risen 1% -- richly-valued companies also frequently pop up. Enterprise software firms are once more well-represented. CrowdStrike, Zendesk and Alteryx are each now down more than 10% this month, as are firms such as Zoom Video Communications and Elastic. A lot of these stocks, it's worth adding, also sold off in September.

What's driving this apparent rotation away from high-multiple tech stocks? Easing trade war worries might be placing some role here.

Part of the bull case for many high-growth software and Internet firms that were granted steep valuations was that -- unlike, say, Apple or many of the chip stocks that spent much of the year trading at low valuations -- they have little or no China exposure. With markets now less worried about their worst-case trade-war fears being realized (even if trade tensions have by no means gone away), some investors might deem the valuation gap that had opened up between a select group of high-growth software and Internet names and most of the rest of the sector to be less justifiable.

Also, some recent events may have served to remind Wall Street that things can potentially go wrong for high-growth darlings as well. Notable examples include Netflix posting a big Q2 subscriber miss, Workday forecasting a growth slowdown for its core business and Uber (once the poster child for consumer tech unicorns) losing its luster after going public.

Regardless of the exact reasons, the narrowing of the valuation gap that had emerged between select high-growth names and most of their tech peers feels healthy. Though nothing comparable to the mania of the Dot-com bubble, pockets of frothiness had clearly emerged in tech. And while some froth still exists, it doesn't look as bad as it did a short while ago.

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TAGS: Investing | Technology

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