5 Places to Find Deals as the Tech Sector Sees a Reckoning

Following month after month of speculative excess, we seem to be finally seeing a reckoning for high-multiple tech stocks in the wake of Jerome Powell & Co.’s recent hawkish turn — a reckoning that’s potentially being worsened by margin calls, blown options bets and fund redemptions.

In spite of this week’s carnage and the Nasdaq’s Friday-afternoon bounce off its lows, I’m not sure we’ve hit bottom yet, particularly in light of Friday night’s crypto tumble. Valuations for many 2021 growth-investor favorites are still high, and it wouldn’t surprise me if we need more capitulation in names such as Tesla (TSLA) , Lucid (LCID) , Rivian (RIVN)  and Cloudflare  (NET) — many of which are still trading well above where they stood a few months ago and/or recently saw parabolic run-ups fueled by speculators looking to quickly earn big gains on their shares and calls. Some genuine capitulation in meme stocks might be necessary, too.

But with that said, valuations appear reasonable for many other tech stocks right now. It’s not just that multiples for a lot of names are low or at least moderate: Demand trends still look healthy across many tech end-markets, consumer and corporate spending mostly look good going into 2022, and yields for longer-dated Treasuries have actually dropped since Powell shared his market-churning comments about inflation and asset-purchase tapering on Tuesday.

That’s why — as someone who has been voicing both bubble and inflation concerns for a while now — I’ll be the first to say that big differences exist between the current tech environment and the one that existed in 2000. While there are clear similarities in terms of speculative excess and get-rich-quick behavior, the multiple-inflation isn’t nearly as broad-based within tech this time (back then, virtually everything from small-caps to the era’s tech giants routinely sported triple-digit P/Es).

In addition, 10-30 year Treasury yields are much lower today than they were back then, and will likely remain that way even if the Fed hikes rates a few times next year. And perhaps most importantly, there isn’t anything on the horizon that looks poised to clobber tech spending the way the collapse of the Dot.com and telecom bubbles led purchases of IT and telecom equipment (and the various chips and components going into these products) to plummet in 2000 and 2001.

For those reasons, what we’re seeing right now across growth stocks, meme stocks and cryptos might better resemble a narrower version of the 1987 crash — a quick, violent downturn that was triggered by some bad macro/policy news and which took a lot of froth out of financial markets, after which many stocks gradually rebounded — than the Dot.com/telecom bubble implosion. If that’s the case, there’s a good chance we haven’t reached the end of the downturn (and of course, one can’t forget that much of the 1987 crash took place on a Monday), but also that we might not have a whole lot of trading days left before we bottom.

With all of that in mind, here are a few parts of the tech sector where I think stocks with compelling risk/rewards can be found for those ready to stomach some additional short-term volatility. As always, investors are advised to do their own research before taking positions in any of the companies mentioned.

1. Beaten-Up Consumer Tech Companies

Investors have soured on many former pandemic beneficiaries in a hurry, pounding their shares to new 52-week lows after the companies generally reported during Q3 earnings season that they’re seeing slowing growth as consumers start going out more.

But dwelling on these short-term headwinds has led many investors to forget about the strength of the long-term, secular, growth drivers many of these companies still have. These growth drivers, such as e-commerce/digital payments adoption, remote learning adoption and the migration of video ad dollars to online channels, leave these companies well-positioned to continue posting healthy double-digit growth over the next several years.

Names That I Like: Chegg (CHGG) , PayPal (PYPL) , Pinterest (PINS) , Peloton (PTON) , Roku (ROKU)

2. Tech Reopening Plays

Reopening plays are kind of in a “damned if you do, damned if you don’t” moment. While former pandemic beneficiaries have been hurt by normalizing consumer behavior patterns, tech firms that benefit from things like greater travel, dining and local events spend are also often trading well below their 52-week highs, as Omicron variant fears drive a fresh bout of selling pressure.

The selloffs have come even though many of these companies already traded at moderate valuations that priced in only gradual demand recoveries. And they’ve continued even though signs have emerged that many of the first documented Omicron cases are mild and that vaccines/boosters still appear to provide a lot of protection against serious illness. As a result, the multiples currently granted to many reopening plays might just look like bargains in six months’ time.

Names That I Like: Booking (BKNG) , Eventbrite (EB) , Expedia (EXPE) , Lyft (LYFT)

3. Moderately Priced Growth Software Companies

This is a field where deals have opened up lately, thanks to both harsh post-earnings selloffs and the extent to which cheaper software stocks have fallen in tandem with their more richly-valued peers.

Regardless, growth drivers for better-positioned enterprise software firms spend look as good as they did at the start of the year: Software continues taking IT budget share from hardware; investments in software fields such as analytics, security, collaboration and data warehousing remain strategic priorities; and cloud/SaaS adoption both steadily fuels share gains for select companies and gradually increases corporate software spend within various end-markets.

Names That I Like at Current Levels: Nutanix (NTNX) , RingCentral (RNG) , Salesforce.com (CRM) , Splunk (SPLK)

4. Low-Multiple Chip Developers

For all the good news that the chip industry has seen this year, many chip developers are valued like they’re pure cyclical plays or close to it. Forward P/Es below 20 still aren’t hard to find for well-positioned chip developers with high margins and differentiated products, while memory makers sport forward P/Es below 10.

But while cyclicality and inventory builds/corrections remain facts of life for the chip industry, it’s hard to ignore how much trends such as rising cloud capex, EV adoption, IoT device proliferation and the growing computing, memory, analog and/or RF needs of various products are set to grow the pie over the course of this decade, even if we inevitably get some down-cycles along the way. The long-term growth story here is something very different than what exists for, say, the oil industry.

Names That I Like: Broadcom (AVGO) , II-VI (IIVI) , Micron (MU) , Qualcomm (QCOM) , Skyworks (SWKS)

5. Low-Multiple/High-Margin Chip Equipment Makers

Much of what applies to chip developers also holds for chip equipment makers. While up and down-cycles will continue impacting these companies, they stand to benefit this decade from both greater chip demand and (thanks in part to the incredible technical complexity of leading-edge manufacturing processes) greater industry capex-intensity. In addition, chip equipment sales will benefit over the next few years from efforts to address major supply shortages (particularly for trailing-edge processes) and to localize a larger portion of chip production.

Yet nonetheless, quality chip equipment firms with sub-20 P/Es remain easy to find. Among these firms, I’m generally more partial to companies possessing relatively high gross margins (i.e., above 40%), as their earnings are typically less vulnerable to seeing massive declines during a down-cycle.

Names That I Like: Applied Materials (AMAT) , Axcelis Technologies (ACLS) , KLA (KLAC) , Kulicke and Soffa (KLIC)

One final comment: Some of the companies that I mentioned in this column as liking are profitable and can be valued based on their near-term EPS or free cash flow (FCF). Others, however, are generating few or no profits for now and need to be valued based on their sales or billings. In a market environment like this one, where the greatest selling pressure is often in companies whose valuations depend heavily on expectations of strong profit growth years into the future, companies that are moderately valued based on short-term EPS/FCF expectations might offer a greater margin of safety.

(SWKS, AMAT and CRM are holdings in the Action Alerts PLUS member club. Want to be alerted before AAP buys or sells these stocks? Learn more now.)