Tech stocks are relatively more expensive now than at the beginning of the year, but it’s okay, because fundamentals are strong.
That’s the view today from Bernstein analysts Toni Sacconaghi and Ann Larson.
Sacconaghi, who follows shares of Apple (AAPL), Hewlett Packard Enterprise (HPE), and International Business Machines (IBM), writes that the average forward price-to-earnings multiple has contracted 4.9% this year for tech names, but that is less than the 11.4% contraction in the market multiple, “meaning that tech has become +650 bps more expensive on a relative on a cap-weighted basis.”
“The upshot,” write Sacconaghi and Larson, “is that tech now trades at 1.10x the S&P 500 multiple, which is still lower than the average of the past ~40 years (1.22x), but higher than the beginning of the year, when tech traded at 1.04x the S&P 500.” Bear in mind, the peak in valuations is still that 1999 to 2000 dot-com period.
The analysts like the outlook for tech’s business, with results from Q4, and his own survey of corporate CIOs, suggesting there was a year-end “budget flush” at companies, but also the prospect of “strong IT spending in 2018.”
All in all, Sacconaghi and Larson recommend a “modest overweight” exposure to tech stocks, and a “balanced barbell” of value names and pricey growth stocks:
While tech relative multiples have expanded by 650 bps YTD, we believe that the relative headwind from tax reform should now be fully priced in, allowing stocks to trade more on fundamentals through year end, which we believe will continue to be solid. Similarly, while growth tech has strongly outperformed value tech year to date (1980 bps on a cap weighted basis, 940 on an equal weighted basis), earnings revisions have been stronger for expensive/growth tech stocks –as a result, relative valuation spreads between inexpensive and expensive tech have not changed much, and are only slightly above historical average levels. Accordingly, we continue to recommend a balanced barbell of expensive and inexpensive tech names.”
Among the value names that Sacconaghi and Larson recommend are HP Inc. (HPQ), and chip maker Broadcom (AVGO). Among the pricier growth names are ServiceNow (NOW), Tableau Software (DATA), Nvidia (NVDA), and Netflix (NFLX).
