I love technology. Innovation is the ultimate engine of wealth creation, transforming the world through the application of science, ambition and a great business plan.
But you need to offer it to me at the right price. And right now it’s clear Wall Street is struggling to keep buying stocks that we’ve been trained to think of as “tech” companies . . . only with the wrong growth profile and at too high a price.
That’s a problem. It’s no wonder the technology-heavy NASDAQ is down over 5% YTD, making a gloomy start to what is normally a season of hope and optimism.
Some massive stocks simply run more on hype than innovation these days. They’ve gotten ahead of themselves.
Maybe they’ll take “the market” down with them. But as we’ve discussed, I am not a prisoner of “the market” and neither are you. If these stocks don’t make sense to you, don’t buy them.
And when you take them off the table, the market as a whole doesn’t look so scary after all.
Start with the big numbers. The S&P 500 is priced for a world of free money at a steep 21X next year’s earnings.
That valuation could be reasonable if we expected the Fed to keep the free money flowing. But we don’t.
And we’d tolerate it if we expected earnings to grow relatively fast in the coming year. That’s a matter of opinion.
All the best minds on Wall Street put together think the S&P 500 will raise the bottom line about 10% in the coming 12 months. Normally that’s worth a healthy 10-11% uptick in stock prices.
This year, however, it’s not clear that the anticipated growth rate will attract a lot of serious buyers. Too much of it is already priced into the market.
But never forget, when we’re talking about “the market” as a whole, there will be stocks that expand fast enough to justify a higher price . . . and those that are cheap enough to compensate for slow growth.
And then you’ll have the nightmare stocks that just aren’t growing fast enough or cheap enough to make sense as an investment. Seven of them have gotten big enough that they now account for 25% of the market as a whole.
They’re not exactly magnificent. Separate them from their reputations and there’s no rational reason to buy or even hold them in your portfolio.
You know their names. Let’s go through them one by one and then circle back to a few of the other 6,000 stocks on Wall Street.
Why Big Tech Is Nervous
Apple might boost its earnings per share 2-3% in the coming year, which is far from the dynamic reputation the company has built over the last decade.
In fact, it’s only a third of the growth we expect from the market as a whole. In return for that sluggish expansion profile, you need to pay 30X future earnings for the stock.
Want to pay a 35% higher multiple for a 65% lower growth rate? Go ahead . . . but don’t tell me you’re concerned with either multiples or growth rates.
Microsoft is a better deal. It also trades around 30X earnings now, but at least management makes a compelling case that they’ll raise the bottom line 15% this year, faster than the market and making Apple look like it’s standing still.
If you have to buy one of these stocks, Microsoft wins the prize. But again, don’t complain about high market multiples when you’re buying in at 30X, twice the long-term average.
After all, my rule of thumb revolves around paying up to the annual growth rate. When you’ve got a company growing 15%, you want to pay around 15X earnings.
Amazon remains one of the wonders of the world. It’s growing at least 8 times as fast as Apple and about 2.5 times as fast as the S&P 500. But that 25% growth costs 63X current earnings.
I wouldn’t pay that unless I was getting at least 3 times the growth of the broad market. As is, the stock isn’t interesting for me above $2,600. There are just too many other places to put my money that make more sense.
Ask yourself why people bought Amazon at such lofty levels. Maybe they were in thrall to Jeff Bezos and his billionaire aura. Maybe they just couldn’t think of anything better to buy.
Either way, if you’re nervous about stocks struggling in a non-zero-rate world ahead, I’d start by trimming my Amazon holdings. You’ll be able to buy it back at a better price when the market regains its equilibrium.
Alphabet is the “discount” member of the group, trading at just 24X earnings . . . only a slight premium to what you’ll get from the S&P 500 as a whole. The problem there is that you’re still paying a premium for what looks like half the earnings growth.
Again, take away the famous name and why are you paying more for less? Safety? Complacency? My subscribers would never settle for that.
NVIDIA is growing a little faster than Microsoft and trading at almost double the multiple. Tesla is growing twice as fast as Amazon and trading at double the multiple. Are you that desperate for excitement?
And then there’s the former Facebook: half the earnings growth of Alphabet, same price. Will the name change to “Meta” move the bottom line? If not, this stock has all the problems of Alphabet and more.
The Rest Of The Market Beckons
The not-so-magnificent seven stocks we’ve just looked at weigh in at roughly 25% of the S&P 500 and account for nearly half of the market’s overall price per dollar of earnings.
To justify that position, they need to deliver double the growth of the S&P 500 in the coming year. I just don’t think that’s likely.
And if confidence falters, they need to drop about 45% to balance the scales.
That’s not even counting any drag from the Fed’s tightening cycle in the coming year. It’s just to bring their overall valuation back down to that 21X multiple some people think is inherently scary on its own.
So don’t worry about those seven stocks. Unless you have a compelling reason as an investor to buy them, don’t buy them. If you’ve made a lot of money on them, consider taking profit and lightening your position.
After all, when you factor these stocks out, the rest of the S&P 500 is priced at about 15X forward earnings and growing about 9% in the coming year. That’s close to the long-term sweet spot.
It’s “average.” Worth an “average” year on Wall Street, roughly a 10% return. But you can’t buy that narrative without finding a way to trim the seven tech stocks near the top.
Those stocks look ready to drive the market as a whole into correction territory. The rest of the market looks eager to rally. Factor them all together, you get a neutral trend . . . stagnation, churn, rotation.
Which end of the market would you rather occupy?