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My view on what's going on in the financial markets and the global economy, and a few other things that might interest me from time to time.

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Tech Unravels: Now What?

Updated: Nov 2, 2020

As tech unravels along with my favourite “non-tech” tech stock TSLA (sarcastic), I thought it might be interesting to look at just how severe this selloff has been. Because I want to be relatively brief, I have used only accessible headline data (from Yahoo Finance) and have confined this analysis more to price action than fundamentals, although I did include forward P/E ratios and price/sales in my analysis and discussion. As you are reading this and looking at the tables, my suggestion is that you focus on a combination of price action in the short term (i.e. the last 7 days) and the long term (admittedly, only one year, but it makes the point). I chose 7 days because it is the period when markets, particularly the “go go” names, were continuing to reach new highs day after day, completely untethered from fundamentals, before getting caught in the downdraft of the last few days. The culprits for this unprecedented market ascendancy, during a deep recession nonetheless, have been written about in all sorts of financial publications recently. The unusual price action has been attributed to “Robinhooders” (pseudonym for a broader constituency meaning unsophisticated retail), the Federal Reserve (artificially low interest rates and unprecedented QE), momentum funds jumping on a “moving train”, short covering of heavily shorted names, and, most recently, SoftBank because of their significant buying of call options of the FAANG+M and similar tech companies.

I have divided the chart below into two because it is hard to present in this format otherwise. The top section is the FAANG+M stocks, plus Zoom and Nividia, and the bottom is TSLA along with two peers (VW and GM) and SoftBank Group vs Apollo Asset Management. SoftBank is arguably fashionable at the moment because of its recently-disclosed options strategy, and this is why I included this company. As you will read, my view is that valuations of these stocks generally remain inflated, but I have not done enough work to pin down an exact level that I would be comfortable investing (and am not an investment advisor, cannot give advice, etc. – see disclosure on website and at end of this article).

I am going to start with TSLA, since it is my favourite stock to hate, as much as I like the company and what it is all about. I have written directly about and alluded to the fact that TSLA has been wildly overvalued time and time again and have obviously been wrong in so far as the stock has continued to head north for reasons I could not possibly comprehend other than a combination of short covering and pure momentum. I have owned TSLA, and perhaps just harbour bitterness at missing out on its tenfold increase in value from one year ago to its highs only one week ago. However, I cannot find any way, whether fundamentals or market opportunity (meaning clean energy), to conclude that TSLA should be so richly valued vis-à-vis its automotive peers and nearly every other stock! The landscape will continue to grow more competitive. TSLA has only $25.7 billion of sales and makes no money from operations yet is still valued at over $300 billion (and recently over $400 billion!), whilst VW and GM – two traditional automotive peers – collectively have nearly $340 billion of sales but combined market value of $138 billion. In other words, TSLA has 8.4% of the collective sales of VW and GM and more than twice the market cap of both together. Go figure. TSLA was rightly excluded from the S&P 500 in my opinion, because its bottom line profitability over the last four quarters were firstly scant, and secondly, less-than-genuine because the core business is not profitable in spite of the accounting figures - red operating results were pushed into the green from the sale of carbon-emission credits not the sale of cars. I can go on and on about TSLA although I fully recognise that there is a powerful and vocal congregation of followers that believe the company is worth infinity. I am not in that camp, and I see further downside for TSLA unless a combination of the faithful and short-covering can somehow stabilise this stock before reality overwhelms momentum. Let’s see.

Let’s turn to the tech names, focused on the FAANG+M stocks. I continue to believe that AAPL and MSFT are the most solid of the lot, but unfortunately, AAPL got caught up in momentum driven by a stock split, which as most of you know, makes no sense mathematically. How severe was the jump? The company’s stock was at $96.19 (all figures adjusted for 4:1 split) on July 30th before the company announced its earnings and stock split, and then peaked on Sept 2nd (see table) at $137.98 (+43% in five weeks). Even at yesterday’s closing price, AAPL is the only FAANG+M stock that is at a price more than twice its level from one year ago! AAPL is a super-solid, liquid, excellent company, but it is not a growth company. My calculations show that the company’s sales growth has averaged 5.1%/annum over the last five years and 3.6%/annum over the last two years. In the graph below from MacroTrends, the top portion is rolling quarterly revenue growth, the middle component is actual quarterly revenues, and the bottom component is the revenue growth compared to the comparable quarter of the year before.

Off of a $250bln or so revenue base, this growth is solid but hardly worthy of an increase in forward P/E from 16.0x one year ago to 31.9x today. My conclusion is that AAPL got severely caught up in hype that I am sure the company would have preferred to avoid (this isn’t Tesla!), and is likely subject to further downside even with its impressive operating performance and its new iPhone (12) about to be announced in the coming weeks (expected Sept 15th). In fact, whilst all the FAANG+M stocks have declined off of recent highs, AAPL has fallen the most, riding technicals up and then back down, almost taking on a life of its own independent of the company’s fundamentals. It sounds so familiar!

As far as the rest of the FAANG+M stocks, both AMZN and NFLX are vying for the next best gainers over the last year. In the case of AMZN, it has always managed its business with less regards for bottom line, choosing to invest in its business by expanding its customer base via aggressive advertising and marketing (inflating operating expenses). Therefore, a more appropriate valuation metric for AMZN is price-to-revenue. In this respect, AMZN is the lowest of its peers, but the company has seen investors push this ratio from 3.9x four quarters ago to 5.4x today. I would think AMZN could experience more downside but did not get caught up in the split euphoria that catapulted AAPL. I have expressed concerns about NFLX for several quarters now, mainly due to its negative cash flow and the growing competitive landscape, but to be fair, its P/E ratio is the only one that has declined over this period. I still see further downside for NFLX, no matter which direction the market goes from here. I believe that MSFT, GOOG and FB probably represent the best values, if you had to buy now, more because they – like the others in this elite list aside from NFLX – are dominant companies in their respective businesses and are well-managed with very strong capital structures. Be wary though of pressure on FB and GOOG related to potential fluctuations in advertising revenues as the pandemic remains far from contained around the world.

As a last word on the FAANG+M stocks, I have extracted a table below from an article published this morning by John Authers (“Correcting a Correction”, Bloomberg Opinion), in which he writes that the FAANG+M stocks have distorted the return on the S&P 500 index, a topic I last covered in (FAANG+M: ‘Up, Up & Away’) on August 27thin an article you can find here. As the graph illustrates, the return of the NYSE FANG+ Index has truly been exceptional – arguably out of line – with the performance of indices without these infamous stocks, including the S&P 500 index (I believe this is without the FAANG+M names although not labelled this way), a global index of stocks ex-US (so excluding the FAANG+M stocks), and the S&P 500 excluding the Information Tech sector (only has some of the FAANG+M stocks).

Mr Authers suggests, and I concur, that the returns outside of these tech names and other “go-go” names has in fact been much more in line with the state of the economy since CV19 surfaced. Carrying this argument on, its suggests that there might still be value in the market in select names if you avoid the stocks that have been caught up in the euphoria for better or worse.

I have also included Zoom Video Communications (ZM) and Nividia (NVDA) in my table, because aside from TSLA, they both had meteoric runs over the last year and are therefore subject to more robust corrections as we have seen over the last week. ZM had excellent earnings and the share rocketed from around $300/share on Aug 28th to an intraday high of $478/share less than one week later. ZM is a stay-at-home stock that served up outstanding earnings, and I believe based on my own usage that Zoom is an excellent product. As an investor, remember the old adage though that a company is one thing and it’s valuation is another. In the case of ZM, it was simply too much, too fast. Keep in mind that ZM has only $622 million of sales (rolling 4Q), although the company is profitable and has been for its last two fiscal years. Still, a market cap in excess of $100 billion seems excessive to me. NVDA is not a company I follow closely, but certainly wish I owned (instead of INTC) as it has proven to be cutting-edge right on top of trends in the chip / semi-conductor business. It is much larger than ZM ($13 billion revenues and consistently profitable), but similar to other tech stocks, arguably has gotten ahead of itself as far as valuation. I see solid performance ahead but not the type of growth that justifies a P/E ratio of over 50x and a price-to-sales of 24x. I think both ZM and NVDA are great stocks to own, but I would not buy either at these levels. I have my eye on both though should they continue to be affected by gravity, which is very possible.

Lastly, I wanted to mention SoftBank since I wrote recently in about the Vision Fund (see “The SoftBank Vision Fund: Trials and Tribulations” from July 16th) in which SoftBank is the sponsor. The company’s involvement in the options market for high-flying tech names was exposed by the Financial Times last weekend. This involvement explains some of the unusual activity in many of tech stocks and the concurrent – and strange – phenomenon of the VIX increasing at the same time that the market was rising. SoftBank is very much “Japan Inc”, so I am not sure the company will be punished by domestic investors like it should in that it seems to be transitioning to an aggressive investment fund more than an operating company which I – rightly or wrongly – always thought of the company as. I have compared SoftBank to Apollo Asset Management, not really a venture capital firm but an aggressive asset manager. SoftBank’s shares have fallen even though its strategy looked initially to be working (less so over the last week), mainly because the company is being exposed for what it is – a de facto hedge fund. I see further downside in the price of SoftBank related to reasons I discussed in detail in my July post regarding Vision Fund.

As I am finishing this article, I am seeing the U.S. futures market – including the recently beleaguered NASDAQ - all solidly green this morning, pointing towards a bounce as has so often been the case during the remarkable market recovery since March. I would not buy any of the stocks I have listed in this article at the moment, and in fact, would sell some if they continue to ascend to levels that I cannot justify in my wildest dreams, whether I like the company or not. Sometimes, you have to take money off the table, at least partially.

Disclosure: I own MSFT, AAPL, AMZN, GOOG and FB, and have – but do not currently own – NFLX, TSLA and ZM. This post is not investment advice, and I am not an investment advisor. Please see disclaimer on website.

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