Pullbacks in the market are normal. They’re not fun – nobody likes being down on their investments – but they’re healthy. You need times of stress to reset expectations and get overzealous investors chasing returns to come back down to earth.
Sometimes during pullbacks investors get fearful and overshoot to the downside – people start to sell first and and ask questions later. It’s a normal behavioral component of the markets.
The recent rise and fall of tech and growth names is no different. Tech names rose during the Covid-19 shutdowns and seemed unstoppable in 2020 and 2021. Then the music stopped – the Fed announced a shift in policy to respond to inflation and all of a sudden the enthusiastic valuations and forward projections started to crumble.
Now, a lot of growth companies are near multi year lows. Some of the falls are justified; for example, companies without competitive edges and long term growth drivers like Peloton. But some companies have been sold off aggressively and could be great additions to your portfolio at bargain prices.
It’s Not The Dot Com Era
Comparisons to the dot com bubble in the late 90s and early 2000s have been everywhere over the past few months as technology valuations have collapsed.
While that comparison might be tempting, it’s also wrong. The dot com bubble saw wild upward movements in companies that didn’t have products, didn’t have businesses, who only had ideas. Today’s technology landscape is very different.
Some recent technology valuations may have been generous in terms of outlook, but broadly, the underlying businesses are sound. Companies like Alphabet or Salesforce generate billions of dollars of free cash flow and post robust revenues. Farther down the food chain where valuations were more aggressive the story is similar. A company like Okta might be priced for aggressive growth over the next several years, but they are still a real company, generating real revenues, with real products.
You can’t talk about growth companies without talking about Tesla
Yet it’s Tesla’s fall from its peaks that’s actually more interesting to us. Tesla coming down was essential – it’s the standard bearer for high valuation technology companies. Whether you like the product or believe wholeheartedly in Elon Musk, the math around Tesla’s valuation is really difficult to understand. They trade at a significant premium to both technology oriented peers and to traditional auto manufacturers. So, when companies like Microsoft
But finally Tesla came down. As we write this, it’s down more than 30% from its high and had been down approximately 40%. That’s the kind of drop that’s more in line with what other large technology companies had seen. That capitulation, seeing Tesla with its hugely loyal investor base finally come down, to us that signals that sentiment on tech is finally starting to bottom.
So We’re Buying Tesla?
Despite Tesla’s fall potentially indicating a turning point, we don’t think that’s necessarily the best name out there. Even after falling, the company still looks expensive – especially as every other car company on the planet is starting to go electric in a competitive way. That, and Elon Musk seems increasingly distracted. The guy is a genius, sure, but he’s still got limited hours in the day. The Boring Company, Space X, and possibly Twitter – Elon has a lot of different things on his plate and all of them by themselves could be full time jobs.
Proceed with Caution
Before we get into the spaces we think are attractive, we have to reiterate that not every fallen tech name is automatically a buy.
People like to look at Tesla and Amazon
For every successful Tesla or Amazon there are dozens of others who fail. According to data from Factset and Bloomberg, between 1980 and 2020, more than 40% of the stocks ever included in the Russell 3000 suffered a drawdown of 70% or more from their peak that wasn’t recovered.
So be careful – not every tech company that’s fallen since the peaks last year is a buy. Some of them were just hype.
Attractive Companies in Attractive Spaces
We are looking for companies in attractive spaces who look like relative bargains after the recent sell offs.
There are a few spaces worth commenting on in particular. First, productivity. The United States is experiencing a labor shock – we don’t have enough workers to fill all the jobs that are open and wages are rising across the spectrum, even as margins are compressed by inflation.
Companies have two ways to try to deal with the situation – they can pay up for higher wages, or they can look for technology solutions to increase productivity. And note, this is a long term trend – our demographic situation isn’t going to improve overnight.
Companies like Salesforce in software or Rockwell in industrial automation are great examples of companies whose products address productivity and have significant competitive advantages over the rest of their peers. Getting the most out of the people you have, setting up automation to reduce the number of people you need to create the same output, that’s the kind of innovation we want to be a part of across industries.
Another space with long term growth prospects is cybersecurity. It’s a nascent space of increasing importance as large companies and countries across the globe put together more comprehensive security solutions. It’s an area where there are going to be some winners and losers; the established behemoths like Microsoft represent a significant threat and there are plenty of innovators in the space. That said, companies like Palo Alto with established user bases and critical security technologies look attractive after the valuation resets we’ve seen in the past few months.
Finally, semiconductors are worth some consideration. In a world where everything is increasingly digital, semiconductors are increasingly important. The space may be highly cyclical but the long term demand outlook is robust. Given the highly competitive nature of the space, more oligopolistic names like Lam Research