Tech Stocks Are Bruised But Not Cheap
It is true that early 2016 has been unkind to the technology market. Check out this chart of the share price to estimated earnings of the S&P 500 information technology sector index, which includes mega-to-medium companies such as Apple, Google's parent company, Intel, Red Hat, eBay and Applied Materials.
In early December, investors were paying about $17.55 for each dollar of expected adjusted earnings over the next 12 months, according to data compiled by Bloomberg. That was the highest forward P/E valuation for the tech sector index since the end of 2009. But within the last two months, the valuation has compressed to just below 15 times, a decline of about 15 percent, as of Friday.
The tech valuation squeeze, of course, is a reflection of the paroxysm in the broader market, with an extra shot of tech-specific panic. Signs of wheezing economic conditions and pauses in business spending are extra bad news for technology firms whose top objective is sales growth. Investors are shunning companies whose businesses are considered long shots or whose stock prices are expensive relative to the market. A lot of tech firms fit that bill.
Tech companies with rich share prices such as LinkedIn, Tableau Software and Amazon -- none of which are included in the S&P 500’s information technology sector index -- have posted earnings that disappointed investors, and their share prices have been punished in response. For the risky, there is no shelter from Mr. Angry Market in 2016.
Yet even in the swoon, technology stocks as a group aren’t a bargain. Or at least not yet.
This chart shows shows the gap between the valuation of the S&P 500 IT sector and the broader index, based on the ratio of price to the next 12 months’ expected adjusted earnings. For most of the last five years, the tech sector has been cheaper than the S&P 500, and that pattern continues to hold. If you are prone to hunting in the bargain bin, the P/Es of the tech sector were far cheaper for most of last year than they are now. 1
The tech sector index as of Thursday's market close was nearly at the median spread over the five-year period, according to Bloomberg data. That means even with technology shares sequestered in Wall Street’s dog house this year, they are still more expensive -- relative to the broader market -- than they have been in half of the trading days during the last five years.
We have seen this movie about tech anxieties not so long ago -- and it feels like barely a hazy memory now. There was also a battering of tech stocks and valuations starting around the spring of 2014. The panic struck many of the same richly valued tech companies like Twitter, Tesla and Workday that are getting hit now.
There was a feeling then that the tech market rout would spell the end of the easy money for Silicon Valley and pop the sky-high valuations for public companies and for startups. Spoiler alert: It didn't. Stock markets recovered, valuations for many public tech companies grew fat again and the next year or so was among the most fertile periods for startup investments in history.
Market routs are unpredictable, and a continued outsized decline for tech stocks could make them look cheap again. It's worth keeping a close eye on market reaction in coming weeks to earnings reports from richly valued tech companies like Salesforce.com and Workday. Right now, investors have no patience for pricey tech baubles that can't meet their high hopes. And impatience is contagious.
On the basis of price-to-sales, valuations of the S&P 500 tech segment index remain far richer than the broader market.
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