It is normal for shares of online broker Robinhood to be down 80% from their peak. Live by meme stock mania, die by meme stock mania. But the big rout in tech stocks is proving uneven. Cryptocurrency platform Coinbase is down 45%, following the trajectory of bitcoin’s decline. Meanwhile, giants like Alphabet have lost around a tenth of their market value.
Expectations of rising interest rates triggered the sell-off. After driving the US market to an all-time high, the tech sector is now dragging it down. The S&P 500 fell 8% from its high point at the start of the year. Reverting to the mean would require an even bigger drop. The index is still trading at 20 times expected earnings. The historical average is less than 15 times.
Look at the cycle-adjusted price-to-earnings multiple – aka the Shiller Cape Index – and it’s clear how expensive stocks are. The index, made popular by Yale economist Robert Shiller, compares prices to inflation-adjusted earnings over the past decade in an effort to smooth fluctuations in earnings. He remains well above the average at 36 times.
However, while a valuation reset is underway, the tech sector should not be viewed as homogenous.
It makes sense for streaming assets to be downgraded, for example. Shares of Netflix are down nearly a quarter after reporting weak subscriber growth figures last week. This is because equities trade on debt-financed growth. Peloton also spent money to expand. Declining user engagement warrants a drop.
Tech giants with rising free cash flow and large net cash positions are a safer bet. Alphabet has $142 billion at hand, for example. Its operating margin should remain close to 30% over the next two years.
Growth forecasts will compare poorly to those released amid the pandemic-driven digital spending boom. But the trends driving this growth have not gone away. According to Gartner, global IT spending is expected to grow more than 5% to $4.5 billion this year. Inflated valuations may be evaporating, but the sector’s usefulness is not.