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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  • tim@emorningcoffee.com

Tech stocks continue to shine: a look back at 1H21

With the first half of 2021 now behind us, I thought it would be a good time to look back and evaluate the performance of the US stock market. Since technology stocks, including many “high-flyers”, have largely stolen centre stage since the pandemic, I thought it would be most interesting to focus on these companies. To evaluate their performance, I developed three groupings of companies:

  1. FAMAG companies,

  2. Seven companies that might be considered the next tier down from the FAMAGs, all of which are profitable albeit smaller (than the FAMAG companies), and all of which have generated returns above the broader baseline indices, and

  3. Eight companies that are, relatively speaking, newer and smaller than the second tier of technology companies. Of these companies, six have never generated a profit. (In retrospect there are many other companies I could have included in this grouping, but I decided to use only these eight because they are the ones that first came to mind.)

I compared both the individual stocks and the three groupings to:

  1. The indices – S&P 500 and the NASDAQ 100 – both of which are readily available in ETFs with near-nil fees, and

  2. Two ETFs that represent “reopening trades”, specifically the XLF (financials) and the IYT (transportation). I looked at these since this trade has been in vogue, and I wanted to compare these sector ETFs against the performance of the tech groupings which I created for this analysis.

Unless otherwise stated, I used data as of June 30th 2021 (end of 1H2021). For valuation metrics, I used price-to-trailingsales and price-to-forward earnings. For the latter, I used forward earnings since the prior quarters were negatively affected in some cases by the pandemic-induced recession. In addition, many of the third grouping of companies were unprofitable in the most recent four quarters but will be profitable in the four quarters ahead. I included sales multiples to be more inclusive, since the price-to-sales ratio includes all 21 of the companies, even those that lose money. There is information is both multiples as far as relative valuations.


With this background, the table below is a summary of my work, including the companies that comprise each grouping, along with headline valuation metrics and select returns.


As the table illustrates, the five FAMAG stocks have a combined market cap (at 6/30/21) of $8.7 billion, representing 24.5% of the value of the S&P 500. This point is often discussed by market professionals because the FAMAGs are very influential in the performance of the S&P 500 more broadly. Both AAPL and MSFT have market capitalisations above $2 trillion, an amazing figure any way you slice it. Interestingly, the FAMAG stocks look over-priced now vis-à-vis the indices, although their multiples are significantly less than the companies in the other two groupings. The FAMAG stocks are often considered core “buy & hold” stocks, often held by investors for many years. Investors have been rewarded, as these companies have generated many years of returns well-above the indices. As you will learn below, the second grouping of technology stocks has generated significantly better returns than FAMAG stocks, not only since the pandemic, but over longer periods of time. The third grouping – “newer tech” companies – suffered in the 1Q21, which largely caused the market-weighted group to underperform the other two groups since all periods end 6/30/21. However, as you can see in the last line – which I have included for reference – this group served up the second-best performance (of the three groups) for calendar year 2020 (1/1/21 to 12/31/20), a period in which six of the top 10 best performers were in this group.


The table below ranks the 21 companies, two indices (S&P 500 and NASDAQ 100) and two ETFs (“reopeners”) by i) market cap of equity (AuM for ETFs), ii) price-to-sales (trailing) and iii) price-to-forward earnings.

As you would expect given my earlier comments, the FAMAG companies are the largest, followed by the “next tier down” tech companies and then the “newer tech” companies, with MTCH being an outlier in terms of size. The multiples of sales and future earnings look rather scary compared to historical levels and to the levels on the indices now, but as you will see in the next table, most of the companies in the second group and several companies in the third group have delivered solid stock performance over the various periods of time that I analysed. Without going much deeper into fundamental analysis company-by-company, I can only generalise and say that most of the companies have historically – for the most part ­– lived up to their heady multiples.


Let’s now turn our attention to returns. The table below shows how the companies rank by historical returns for three short periods of time, all of which end on 6/30/2021 (end of 1H2021):

  1. 1.5 years, from 12/31/2019 (before the pandemic) to the end of 1H2021 (6/30/21), including dividends, with the return shown on a per annum basis (compound annual growth rate, or CAGR),

  2. The most recent one year, including dividends, from 6/30/20 to 6/30/21, and

  3. The most recent six months, including dividends, from 12/31/20 to 6/30/21, with the return for the six month period annualised (so that it is comparable to the 1.5 years and one year periods).

My conclusions looking at this table are twofold. Firstly, for those investors that did not panic as the pandemic was unfolding in late 1Q2020/early 2Q2020, you were rewarded by sticking to your guns if you were an investor in nearly any of these technology stocks. Every stock in every grouping outperformed the S&P 500 since 12/31/19, and only NFLX underperformed the NASDAQ 100. Returns were a minimum of twice as good as the S&P 500 over this period, with some stocks – like ZM and TSLA – outperforming the S&P 500 by 10 times or more! The picture changes though when you look at 1H2021 (returns annualised) in isolation. Over this period, nine of the 21 stocks across all groupings underperformed the S&P 500 and the NASDAQ 100, and five stocks (UBER, NFLX, TSLA, TDOC and PTON) had negative returns. The star performers were equally diversified across groups though, with NVDA (announced 4-for-1 stock split in May, effective July 20th) being the star performer, followed by GOOGL, ROKU, SHOP and FB – a good mix across groupings – generating the next best performance. The “reflation trade”, as expressed through the financial sector and transportation ETFs, also performed significantly better in 1H21, reflecting the rotation that was occurring and which was especially pronounced in the first quarter. Still, the performance of these two “reopening” sectors was significantly less than the better-performing technology stocks.


The final table below looks at average annual returns over slightly longer periods of times, all excluding dividends. The periods considered include:

  1. The last five years (6/30/16 to 6/30/21), noting that some of the companies in the second (one) and third (six) groups were not public in 2016 so are not able to provide returns over this period,

  2. The most recent three years (6/30/18 to 6/30/21), with a similar caveat as for the five-year period, and

  3. The most recent one year (6/30/20 to 6/30/21), excluding dividends in this table to make the results more comparable to the prior two periods. (Note DASH listed Dec 2020).

The first thing this table shows is the relative outperformance of most of these companies vis-à-vis the indices (S&P 500 in particular) over longer periods, no matter whether you look at one, three or five years. Secondly, the table shows that over all three periods, seven of the companies in the second and third groups have out-performed the best-performing FAMAG stock in each period. It is difficult to be disappointed with the FAMAG stock returns over the last five years, which ranged from 25%/annum (FB) to 44%/annum (AAPL). This is especially true when comparing these returns to the return on the S&P 500 (15%/annum). However, had you had the vision and conviction to buy names like SHOP, ROKU, NVDA, MTCH, TSLA (until recently) or SQ five years ago or at their IPO (if listed less than five years ago), you would have done remarkably well. Moreover, as valuations caused investors that preferred to trade in-and-out to sell certain stocks as their valuations soared to what appeared to be unsustainable levels, these investors were the (relative) losers vis-à-vis those investors with a truly longer-term perspective. There is little debate that these buy-and-hold investors have been richly rewarded so far.


To assume that the unusually supportive conditions we have today – super-accommodative monetary stimulus and wave after wave of fiscal stimulus – will continue indefinitely is undoubtedly a fool’s game. However, trying to guess when investor sentiment might change as the stimulus measures wear off – and they eventually will – is equally difficult. The key will be to identify in advance the catalyst or catalysts that would trigger such a change in sentiment. So far, even though numerous pundits have signalled the end of this amazing bull cycle, none have been right, at least not yet.


The major conclusion I draw from this analysis is that investors are generally best served by selecting strong companies and sticking with them, even if they might go through periods of time where they look expensive and are therefore exposed to a correction. Recent history has shown that in most cases, the expensive stocks have also delivered turbo-charged returns, significantly better than the broader indices. The one thing that would cause me to alter this “buy-and-hold” approach is a dramatic and visible change in company fundamentals, which might include, for example, questionable quality and sustainability of earnings, new / stricter government regulation, increasing competition / lower barriers to entry, an unusual change in management or strategy, and so on. In my analysis, the second group of “next tier down” tech stocks (market-weighted) significantly outperformed the FAMAG stocks, although the FAMAG stocks have significantly outperformed the indices. The third group of stocks has a wider dispersion of returns and was most hurt by the selloff in 1Q21. Even so, this group has component companies that have outperformed the FAMAG stocks over most periods, whilst a few of the companies have disappointed. In the case of “newer tech”, it is a matter of picking the winners. An investor should not be disappointed if his or her focus has been the FAMAG companies, because these have done remarkably well. Investors want to own technology stocks, because they can grow quickly if they are in the right markets with the right management. Therefore, even though they often appear expensive based on traditional valuation techniques like trailing sales or future earnings, investors tend to pile into these stocks for good reason. By doing so, this buying pressure prolongs high valuations, as prices push higher and higher, often reaching uncomfortable levels for many traditional investors (like me). If only I could go back in time…….

 

This article is not a recommendation to buy or sell stock in any of these companies. I am not an investment advisor. I have had positions in many of these stocks and currently have positions in: MSFT, GOOGL, AMZN, AAPL, MTCH, NVDA, SHOP, ZM, PINS and PTON.


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