Microsoft stock is up 45% so far this year.
Gerard Julien/AFP via Getty Images
After Big Tech stocks’ parabolic run, the debate now is whether to hold them or fold them. Strategists at
Citi
argue that the shares look more like sells.
The question comes up because
Nvidia
(ticker: NVDA),
Microsoft
(MSFT),
Meta Platforms
(META) and
Alphabet
(GOOGL) have seen their stocks soar between 40% and about 200% this year. That has catapulted the
Nasdaq 100
Index to a gain of almost 40%.
For Nvidia, fueling the surge have been expectations that advances in artificial intelligence will expand demand for the company’s semiconductors. Microsoft, an investor in OpenAI, the creator of ChatGPT, is expected to benefit not only from incorporating the technology into its Bing search engine, but also from layering AI into its cloud offering, helping to expand the market for it. For the internet, AI enhances Google and Meta’s advertising offerings, making them more compelling to brands.
All that optimism has lifted valuations—the stocks’ prices relative to the per-share earnings they are expected to deliver over the near term. Investors are paying up because they expect profits to grow for many years.
Valuations are a key part of the argument for selling now. Barron’s recently argued that tech multiples aren’t so expensive when adjusting them for the earnings growth Wall Street expects. But a look at history and a comparison of tech valuations to those in other sectors tells a different story.
Citi compared the Nasdaq 100’s forward price/earnings ratio, at just over 27 times, according to FactSet, with the roughly 18 times for the S&P 1500, a metric the bank selected because it encapsulates many stocks across sectors. The Nasdaq 100 rarely trades at a premium much higher than this, according to Citi, and when it does, the average move the following year is a loss of 20%.
Other data imply that investors are indeed overpaying for tech’s earnings growth potential. Many tech groups within the S&P 1500 are expected to see EPS growth outpace the broader index’s growth by about three to six percentage points. But some of those stocks’ valuations are far higher than for the index.
Premiums vary, but one group of companies has traded at an average multiple five points higher than the S&P 1500 over the past five years, while valuations for a second group have been some 10 points higher. Those are big gaps: Premiums have averaged only one to three points in the past 20 years.
This isn’t to say tech is necessarily in a bubble, or that these stocks are absolutely certain to see the double-digits drops they have faced in the past. Earnings growth could potentially take the stock prices higher over the years if investors remain willing to pay up now for future profits.
And there is a case that they will. AI seems to be real, as shown by how much Nvidia’s sales guidance surpassed analysts’ estimates in its latest quarter. Brian Macauley, portfolio manager at Broad Run Investments, said he is looking for many years of earnings growth at Alphabet, a stock the firm owns.
The real point is that there is some possibility that tech stumbles, or that it won’t be able to sustain its recent performance. Other opportunities in the market might look better, such as economically sensitive stocks outside of tech, which are positioned to thrive as the Fed eventually stops raising rates, allowing demand for goods and services to take off.
“Sell tech” isn’t a wild idea by any stretch.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com