Tech Stock Freakout Sets In


By: R. Scott Raynovich

Leading technology stocks, including the infamous "FANG" -- Facebook (FB), Amazon (AMZN), Netflix (NFLX), and Google (GOOGL) -- today continued a selloff that started on Friday after some research reports triggered concern about share valuations.

Selling among technology shares was broad-based, with leaders such as Facebook down $4.50 (3 percent) to $145, Amazon down $29 (3 percent) to $949, Netflix down $7.66 (5 percent) to $150, and Google parent Alphabet Inc. down $27 (2.7 percent) to $943 in AM trading. Another big technology leader, Apple, fell $4.69 (3.11 percent) to $144.29, following a downgrade by Mizuho Securities.

Is it the start of something bigger or simply a short-term correction? Tech investors appear to have fallen into an existential crisis with a flurry of debate about the merits of the tech advance this year. For example, as of early last week, FANG gains had accounted for as much as one-third of the percent of the gains in the S&P Index so far in 2017, making up a disproportionate advance.

One of the triggers last Friday was a report from Goldman Sachs analyst Robert Boroujerdi, in which he expressed concerns that some tech stocks were not profitable enough to justify their lofty valuations, even though they are nowhere near approaching the bubble-like valuations of the 2000 era.

Boroujerdi took a look at his own group of stocks dubbed "FAAMG" -- take FANG and add Apple and Microsoft. These top tech companies account for 13 percent of the market value weighting in the S&P 500, even though they are only 1 percent of the companies in the index.

It has been a remarkably lopsided market in 2017. While the FANG stocks have rallied -- up a combined average of 30 percent last week before the correction -- CNBC recently pointed out that 3 of 11 sectors (energy, telecommunications services, and financials) are down by an average of 7.7 percent. Before this correction, Facebook was up 33 percent, Amazon up 34 percent, Netflix was 33 percent, and Alphabet was up 26 percent at the beginning of last week. They've now shed a collective average of about 8 to 10 percent.

UBS analysts said the panic was "much ado about nothing," pointing out that seeing high share gains from a number of leaders is not unusual. The FAAMG stocks, or the "High Fives" as UBS refers to them, accounted for approximately one-third of the S&P 500's YTD gain, says UBS. How unusual is this? Not very, says UBS: "Since 1993, there have been four years of comparable return 'clustering' in positive S&P 500 years -- 1993, 1999, 2005 and 2007. What is notable is that of the four previous years, MSFT (1999, 2007) and AAPL (2005, 2007) appear twice, and in 2000, MSFT declined 62.8% while in 2008 MSFT was -45.4% and AAPL was -56.9%; such declines now appear as blips on a long term chart (Figure1). Given the past several years' rally, can Tech continue outperforming into 2018?"

What's the answer? UBS says to buy on weakness: "Growth in earnings, reasonable valuations, and cash eligible for repatriation (AAPL has more than 25% of market cap in offshore cash) are all reasons to expect Tech to continue outperforming in the long term. Absent significant additional multiple expansion or a sharp acceleration of inflows, we'd look for 'seminal events' such as AAPL's attaining a $1TRN market cap or a blockbuster merger announcement similar to 2000's AOL/TWX as guideposts for curbing Technology enthusiasm."

What's interesting is that lumping all of these technology stocks together does not make a whole lot of sense. They are characterized by wide ranges in valuation. For example, Netflix trades at a forward price/earnings ratio of 83 and has a P/E/growth (P/E ratio divided by the earnings growth rate) of 2.51. In contrast, Apple trades at a forward P/E of 14 and a PEG of 1.57 and Microsoft has a forward P/E of 21 and a PEG of 3.3 (lower PEG is better). Amazon is still off the charts with a forward P/E of 86 and a PEG of 6.6.

Below is a quick table showing the large variations in these metrics for some of the major technology stocks that we follow.

Company Forward P/E PEG ratio Dividend Yield Recent Price

Amazon (AMZN) 86 6.6 N/A $955
Apple (AAPL) 14 1.57 1.7% $144
Cisco (CSCO 13 1.5 3.7% $31.50
Facebook (FB) 25 1.5 N/A $146
Microsoft (MSFT) 21 3.3 2.2% $67
Netflix (NFLX) 83 2.51 N/A $151
Oracle (ORCL) 16 2.5 1.4% $44
Qualcomm (QCOM) 14 1.8 4% $57

More mature companies, such as Apple, Cisco, and Microsoft, have become attractive for the cashflows and dividends. Amazon and Netflix are favorites of momentum investors -- and they sport momentum valuations. Facebook is in a category of its own -- a reasonable valuation for a high-growth business, with no dividend. So why does Wall Street like to lump stocks together when their businesses and valuations are widely divergent?

There is no doubt that the technology sector, after its market-leading run, needs to have some of the air taken out of it and allow shares to settle back into more comfortable valuations. The recent expectations for big changes in economic programs (tax cuts, etc.) had gotten ahead of themselves given the constant turmoil in Washington, and we have entered a more soft seasonal period for stocks. This summer may present some opportunity for bargain shopping in technology shares.

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