From the Field
What is your view on current valuations in technology?
A look back through history and why Dom Rizzo thinks most of the technology universe still has reasonable valuations today.
May 2024 - Dominic Rizzo, Portfolio Manager
Transcript
Well, I think this is why it's so important to have an investment framework. When you're investing in global technology stocks, you need to focus on those linchpin technologies that are innovating in secular growth markets with improving fundamentals. But you also need to make sure you pay a reasonable valuation for those stocks. Many investors learned that lesson the hard way post COVID as interest rates went from 0% to 5%.
So let's take a look at the global valuations of many of the most talked about names. The Magnificent 7 are the poster child for these tech stocks that have gone up a lot and may look expensive optically, but I think we need to take a step back with those seven stocks. There've been two other periods of history in markets with somewhat similar global market concentration. One was during the Nifty 50 and one was during the Internet bubble. And if we look at those two different periods, let's go study some of those valuations. During the Nifty 50, those stocks traded at roughly 34 times earnings if you looked two years out. During the tech bubble, many of those stocks traded over 50 times earnings. Cisco, the poster child, traded at over 100 times earnings. Now let's look at those Mag 7 stocks. Broadly speaking, they trade at a mid to high 20s PE multiple if you look out two years. Not only that, they have some of the highest returns on equity in the entire market and they grow earnings faster than the rest of the market. In any given year, those Magnificent 7 stocks may grow earnings 2 to 3X faster than the rest of the 400 plus stocks in the S&P 500. And if you look at those valuations versus the rest of the market, they're actually pretty reasonable if you adjust for the growth rates. Those other stocks trade at roughly 17 times earnings today depending on the day. The Mag 7 trades at mid to high 20s, but they grow earnings over 2 times as fast. So, if you look at those PE multiples on a growth adjusted basis, I actually think most of the technology universe has still pretty reasonable valuations today.
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Definition of Terms
Artificial intelligence (AI) is the branch of computer science involved with the design of computers, robots, programmed devices, and software applications having the capacity to imitate human intelligence and thought.
Compound annual growth rate (CAGR) is the rate of return that would be required for an investment to grow from its beginning balance to its ending balance, assuming the profits were reinvested at the end of each period of the investment’s life span.
Dynamic random-access memory (dynamic RAM or DRAM) is a type of random-access memory (RAM). All RAM types, including DRAM, are volatile memory that stores bits of data in transistors. This memory is located closer to the processor, so a computer can easily and quickly access it.
Graphic processing unit (GPU) is a secondary processor usually dedicated to performing the calculations necessary for producing computer graphics, lessening the burden on the main processor.
Magnificent Seven are Apple, Alphabet, Amazon, Meta, Microsoft, NVIDIA, and Tesla.
Price-to-earnings (P/E) ratio measures a company's share price relative to its earnings per share (EPS).
Return on investment (ROI) measures the profitability of an investment by comparing the gain or loss to its cost.
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Risk Considerations: Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. Investing in technology stocks entails specific risks, including the potential for wide variations in performance and usually wide price swings, both up and down. Technology companies can be affected by, among other things, intense competition, government regulation, earnings disappointments, dependency on patent protection, and rapid obsolescence of products and services due to technological innovations or changing consumer preferences. Growth stocks are subject to the volatility inherent in common stock investing, and their share price may fluctuate more than that of income-oriented stocks. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates; differences in market structure and liquidity; as well as specific country, regional, and economic developments. All charts and tables are shown for illustrative purposes only. Investments concentrating in a specific sector can be more volatile than investments in a broader range of industries. Diversification cannot assure a profit or protect against loss in a declining market.
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