Investors’ love affair with technology stocks has cooled off noticeably this year.
And while the upcoming deluge of earnings from the group may offer an opportunity to rekindle the romance, tech faces an uphill battle in commanding the type of devotion it once enjoyed in the stock market.
After trouncing all other sectors in 2020, tech stocks in the S&P 500 Index have drifted toward the back of the pack this year, out-performed by sectors like financials and industrials perceived to have better growth prospects. Bulls are betting that strong results and forecasts from companies like Apple Inc. will help catapult tech back to the forefront, yet lofty valuations pose a challenge.
“If these companies want to return to share-price growth, they need to have a good story about where growth is going to come from and when,” said Kim Forrest, chief investment officer at Bokeh Capital Partners.
A rally in the past two weeks has returned the tech-heavy Nasdaq 100 Index to a record this month after rising interest rates and concerns the stocks were too expensive sent the benchmark down 11% in early March. While tech is once again leading the market for the month of April, an advance of 9.9% for the group in the S&P 500 this year still trails seven of the 11 other main industries.
As is usually the case, the tech group is expected to post strong growth in sales and earnings. What’s different this time is that growth in much of the rest of the market will be even better this year, flattered by comparisons to the same period in 2020 when broad swathes of the economy were shut down.
Technology companies are expected to lead the S&P 500 with 16% revenue growth in the first quarter, according to data compiled by Bloomberg Intelligence.
Projections for the rest of the year, however, aren’t quite as bright. Growth is expected to be just 5.6% in the fourth quarter. In terms of profit expansion, tech looks even less appealing with estimates for 2021 at 22% — an impressive performance, to be sure, but one that would lag behind financials, industrials, consumer discretionary and materials.
For the bears, even beating those growth projections isn’t enough to support valuations that are the highest in years. At 41 times trailing profits, the Nasdaq 100 is trading at the most-expensive valuation since 2004.
Investors who are fretting about valuations are underestimating revenue growth potential for many technology companies like Microsoft Corp. and cybersecurity company Zscaler Inc. that are poised to capture even more spending from companies investing in digital services, according to Daniel Ives, an analyst with Wedbush Securities Inc.
“What’s been lost in the noise is the massive underlying fundamental growth stories that are happening as part of the digital transformation,” said Ives. “Across the board, it’s going to be a domination quarter for the tech space.”
Trailing the S&P
Amazon.com Inc. is the only company among the top five projected to see its revenue growth shrink this year, according to data compiled by Bloomberg. That’s hardly a surprise considering how much its core businesses like e-commerce and web services surged in 2020 as a result of U.S. lockdowns.
Alphabet Inc., Facebook Inc., Apple and Microsoft are all expected to see revenue growth accelerate in their current fiscal years.
Amazon and Apple, the two best performing megacap stocks last year, have trailed the S&P 500 in 2021. Amazon has gained 4.4%, while Apple has advanced just 1.1%.
Some of the most-expensive software companies, in particular, have taken a beating so far this year. Coupa Software Inc., a maker of expense management software that trades at nearly 30 times this year’s projected sales, has fallen more than 20%.
For some investors, elevated valuations are not ignored so easily.
“Tech stocks are extremely expensive historically,” said Michael O’Rourke, chief market strategist at Jonestrading. “Even if the optimistic earnings forecasts are met, the market would still be very expensive.”
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