December 11, 2023

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The issue of selling high-tech stocks such as Nvidia and Microsoft

After a parabolic run for big tech stocks, the debate is now about whether to hold them or fold. Citi strategists argue that stocks look more like a sell-off.

The question arises because Nvidia (stock ticker: NVDA), Microsoft (MSFT), Meta Platforms (META), and Alphabet (GOOGL) have seen their shares rise between 40% and nearly 200% this year. This sent the Nasdaq 100 up nearly 40%.

For Nvidia, the forecast driving the increase in artificial intelligence was an increase in demand for the company’s semiconductors. Microsoft, an investor in ChatGPT creator OpenAI, is expected to benefit not only from integrating the technology into its Bing search engine, but also from integrating artificial intelligence into its cloud offerings, helping expand the market for it. For the Internet, AI improves Google and Meta Ads offerings, making them more compelling for brands.

All of this optimism has pushed up valuations – share prices relative to the earnings per share they are expected to generate in the near term. Investors pay money because they expect earnings to grow for many years.

Ratings are an essential part of the sell now argument. Barron He recently argued that technical multiples aren’t that expensive when adjusted for the earnings growth Wall Street expects. But a look at history and comparison of technical valuations with those in other sectors tells a different story.

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Citi compared the forward price/earnings ratio for the Nasdaq 100, just over 27 times, according to FactSet, with about 18 times for the S&P 1500, a metric the bank chose because it includes many stocks across sectors. Rarely does the Nasdaq 100 trade at a premium much higher than this, according to Citi, and when it does, the average move in the following year is a 20% loss.

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Other data suggests that investors are already overpaying for the technology’s earnings growth potential. Many technology groups in the S&P 1500 are expected to see EPS growth outpace growth in the broader index by about three to six percentage points. But some of those stocks’ valuations are much higher than those of the index.

Premiums vary, but one group of companies has traded an average of five points higher than the S&P 1500 over the past five years, while valuations for a second group have been about 10 points higher. These are big gaps: Premiums have averaged only one to three points in the past 20 years.

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This doesn’t mean that technology is necessarily in a bubble, or that these stocks are absolutely certain to see twice as many declines as they have faced in the past. Dividend growth can cause stock prices to rise over the years if investors remain willing to pay now for future dividends.

And there is a case that they will. The AI ​​appears to be real, as evidenced by how much Nvidia’s sales guidance beat analyst estimates in its most recent quarter. Brian McCauley, portfolio manager at Broad Run Investments, said he’s looking forward to many years of earnings growth at Alphabet, a stock the company owns.

The real point is that there is some possibility that the technology is faltering, or that it will not be able to maintain its recent performance. Other opportunities in the market may look better, such as economically sensitive stocks outside of technology, which are positioned to thrive as the Federal Reserve eventually stops raising prices, allowing demand for goods and services to take off.

“Selling technology” is by no means a wild idea.

Write to Jacob Sonenshine at [email protected]