Are Apple, Alphabet, Meta, Microsoft and Tesla a tech bubble on the stock market?
The US stock market faces a new bubble in the tech sector, and opportunities on Wall Street for value investors. Comment by Rui Cardoso, co-portfolio manager of BA Beutel Goodman US Value
The US stock market is currently characterized by a large dichotomy between a small number of large-cap stocks and the rest of the market. Aside from these mega-caps, the rest of the market is mostly ignored or depressed. We therefore see opportunities in stocks and sectors trading at depressed levels. If you look at the S&P 500, it may seem like there aren't many value opportunities, but if you dig a little deeper, you see some great opportunities across different types of stocks and sectors.
Sectors to keep an eye on
Value investors often expose themselves to sectors such as energy, mining, utilities or real estate. We focus on the quality of companies. If interest rates were to remain higher for longer, we would avoid companies with balance sheet risk and high leverage, especially in the next two years when they will have to refinance their debt.
As value investors, we see value in sectors like pharmaceuticals. This is an industry that appears to be quite depressed, aside from diabetes and weight loss drug companies like Eli Lilly. These are very expensive stocks, but the rest of the sector is quite attractive valuation-wise. Consumer goods are another area that the market is largely ignoring. The sector is expensive, but there are also some large companies that are near depressed valuation levels.
The risk of a new tech bubble
When valuations are this high, expectations for future growth and profitability are difficult to meet. Investors' attention is undoubtedly focused on the "Magnificent Seven". Amazon, Apple , Alphabet, Meta, Microsoft, Nvidia and Tesla currently have very high valuations that suggest a new tech bubble. These companies are fundamentally sound, but the gap between growth and value stocks is as wide right now as it has been since 2000. The Magnificent Seven, which are driving most of the market's performance, have valuations of 27 times earnings, while the Russell 1000 Value Index stood at about 15 times earnings at the end of September. We believe this gap is unsustainable and could lead to a recovery in value stocks or a reduction in valuations of growth stocks.
In our view, this bubble is based on valuations and not fundamentals. The businesses of these companies are doing quite well, but as these markets mature (Apple, for example, in the sale of mobile phones), it will probably be more difficult for them to gain further market share. Their position is now so dominant that it will be difficult for them to grow in the next ten years as they have done in the last ten. Yet, the multiple of these companies is higher than it was ten years ago. This, in our opinion, is incorrect. As the market realizes that end markets are becoming mature, multiples are likely to decline. That's what happened in the early 2000s. But the market could also fall quickly, if there were an external shock that we don't yet see: for example, cloud spending slows down much faster than investors expect, or l The rise of new disruptors are both possibilities.
Value opportunities in the technology sector
We see great value in some technology stocks in specific sectors. One of our largest holdings is Amdocs, which makes telecommunications software. The company is dominant in its sector, with trusted relationships with customers (which include Vodafone and Telefonica in Europe and Latin America). Amdocs is based in the United States and its software must be installed, maintained and updated; therefore, customer ties are strong and long-term relationships typically generate a lot of cash flow. Earnings growth has been steady, but the market has largely overlooked the stock. Despite being a well-managed company with a strong balance sheet, it has a much lower valuation than the overall market and IT sector. The same goes for other technology stocks in our portfolio.
Many of the standards for 5G, 4G and 3G come from Qualcomm, which holds a dominant position in its industry. The company receives royalties for every phone sold, which has made it a very profitable business. The company also produces semiconductors, but is trading at a depressed valuation largely because the market believes the cell phone market is now mature. The market thinks this for Qualcomm, but doesn't necessarily think this for Apple, so in our opinion this is a big discrepancy. For Qualcomm there is also the risk that Apple produces its own chips.
So, let's say the cell phone market is mature and sales decline. Qualcomm should still be able to grow, as it may shift more into industrial and automotive uses of its technology. Our cars are becoming like large smartphones and, in our opinion, Qualcomm is well positioned to seize new market opportunities.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/bolla-tech-borsa/ on Sun, 10 Dec 2023 06:29:41 +0000.