Press "Enter" to skip to content

Are Technology Stocks Headed For a Fal

3th05 0

TECHNOLOGY STOCKS HAVE led the surge from the market’s March lows, continuing a multi-year trend. Over the past five years, the “FAAMG” group, an abbreviation coined by Goldman Sachs (ticker: GS) for five of the top-performing tech stocks in the market – Facebook (FB), Amazon (AMZN), Apple (AAPL), Microsoft (MSFT) and Google (GOOG), have added the most in market capitalization to the S&P 500, compared with the other companies in the index.

Many investors see the rapid rise in technology stock valuations as a prelude to a repeat of the dot-com bust of the early 2000s. Some classic preconditions are in place to support an asset bubble, but there are some important differences making the doomsday scenario for technology stocks less likely.

The following factors make it possible for the technology stock rally to continue:

Tech giants well-positioned for growth. Today’s technology leaders have sustainable business models, little debt and strong revenue growth. In the 1990s, many dot-com companies had no profits, an uncertain path to profitability and huge valuations. Today, platform companies such as Apple, Amazon and Google benefit from network effects in which users beget more users. “Winner takes all” or “winner takes most” markets typically boast higher profit margins, cash flows and pricing power compared with more fragmented markets. The power of platforms has been reinforced during the pandemic, with technology leaders projected to continue growing while much of the rest of the S&P 500 experiences a collapse in earnings.

The rapid rise of digitization. The pandemic is accelerating the adoption of technology platforms. Shutdowns have accelerated trends in online shopping, video streaming and cloud computing. Companies thriving during the pandemic benefit from social distancing, with growth in platform usage likely to continue even after social distancing measures ease.

More than meets the eye in tech stock valuations. FAAMG stocks represent more than 20% of the S&P 500 market capitalization, a concentration uncomfortably high for investors with long memories. Tesla, if added to the S&P 500, would likely enter as a top 10 position at approximately 1% of the index. However, the FAAMG stocks arguably may have justified their status in the index by delivering about 16% of index earnings, according to Natixis. Valuations for the technology leaders are elevated relative to the rest of the market, but remain below dot-com peaks. Interest rates are far below dot-com levels, which justifies higher price-earning ratios, particularly for rapidly growing companies.

Despite the compelling merits of many leading technology companies, the positive narrative around technology stocks may already be priced into the market. Consequently, the outlook may be more challenging than technology stock boosters are assuming.