Is it time to buy the technology sell-off and load up on some of the market’s top growth stocks? It is one of the biggest questions currently facing DIY investors and the answer may depend on your own personal circumstances.

However, in our view there is a strong case for buying some of the higher quality tech names caught up in the recent correction. Particularly if they are already generating profit and cash flow.

Steep 2022 share price falls for the likes of Microsoft, Apple, Amazon, Adobe, Netflix, ASML, Nvidia and more could be a golden opportunity to load up on some of the best growth companies around.

Despite a recent fightback, aided by strong earnings reports, so far this year the Nasdaq Composite has lost nearly 10%, and the tech-laden index is down 11.3% since its all-time 16,057.44 record hit in November 2021. That’s well into correction territory, when the price falls 10% or more below its recent peak. A full bear market kicks in when falls hit 20%.

THIRD OF STOCKS HALVED

According to Ned Davis Research, as cited by Bloomberg, in January 36% of the stocks in the index had plunged at least 50% from their 52-week highs. Historically, when the Nasdaq stands within 10% of its all-time peak, only 12.5% of its stocks have tumbled that much on average, the Ned Davis study said.

The difference this time around is that the Nasdaq’s biggest stocks are holding up reasonably well, and those companies have an outsized impact on the index, given that it’s market capitalisation weighted. In other words, the bigger a company’s value, the larger its impact on the wider market performance.

For example, Apple has fallen just 4% from its 52-week high (incidentally, chalked-up early in January this year), Alphabet is down 11%, Microsoft 11%, Facebook-owner Meta Platforms 19% and Amazon 21%.

‘Microsoft is a bellwether and it is giving a really strong signal of continued demand in the cloud computing space, not just for Microsoft but for suppliers to cloud technology,’ said JoAnne
Feeney, Advisors Capital Management partner and portfolio manager.

The threat of rising interest rates has hurt all tech stocks but it seems to be hurting less mature, unprofitable companies more than most.

Ark Invest’s US-based Innovation ETF – seen by analysts as a proxy for unprofitable and speculative technology companies – has plunged 32% this year and is more than 50% off its 52-week high. Its biggest five holdings – Tesla, Roku, Teladoc, Zoom and Coinbase – are all down substantially on their 52-week peaks.

‘I think it’s violent and unpleasant repricing, but I don’t think it will end up derailing the year,’ said Lori Calvasina, head of US equity strategy at RBC.

‘For Nasdaq, it’s a valuation reset,’ she said. ‘For the most part, this is a reaction to the monetary backdrop, not a growth scare. To really knock the market down in a significant and lasting way, you need to really have investors question whether the economy is risking recession.’

VALUATIONS RECOVERY

Advisors Capital’s Feeney believes that growth this year is likely to slow from the big recovery seen in 2021 but companies like Apple, Microsoft, Broadcom still have strong drivers in place and they should be among the fastest growers in terms of revenue and earnings.

‘That’s why we believe valuations for companies like these will recover this year,’ the fund manager said. ‘Some of these technology opportunities have become extremely attractive after recent pullbacks.’

Many retail investors have taken the hint and bought the dips during the savage selling, snapping up shares that funds have shed from their portfolios in light of a more hawkish Federal Reserve, but with a focus on quality stocks as opposed to speculative names.

Craig Richardson, who is involved in running a small private fund, accepts that markets get ahead of themselves with regular pullbacks, but what seems clear to him is that the very largest tech companies continue to develop their products and services, and pile money into R&D (research and development).

Apple, Meta Platforms (aka Facebook), Microsoft, Amazon and Google-owner Alphabet spend around 50% of their operational cash flows on R&D and investment capex compared to approximately 6% on average for non-tech S&P companies.

‘That’s why I believe they are the cash cow defensive moats of tomorrow – they’re proven having traded through many economic cycles,’ says Richardson.

Legendary investor Mark Mobius called the tech sell-off a good time to look at FAANG stocks, referring to names mentioned above and including Netflix, although the acronym is increasingly anachronistic.

Mobius, a veteran emerging-markets investor and the founder of Mobius Capital Partners, said he was keen on mega tech names like Apple, Amazon, Netflix and Alphabet because they’re strong earners.

‘Those companies that have been hit as a result of the overall decline in tech stocks, that are making money, that have a good return on capital that are growing… these are great buys right now,’ he said.

Billionaire investor Bill Ackman, who built the Pershing Square Capital Management hedge fund business, has built a new stake in Netflix worth more than $1 billion since its stock price tumbled on 20 January 2022 following its subscriber growth warning.

Return on capital, alongside return on equity and free cash flow are three of the most closely watched valuation measurements when assessing high-quality stocks. These measure how effective a company is at getting bang for its investment buck, how hard it sweats the money shareholders invest to create extra value, and how efficient a company is at turning profits into cash.

Microsoft, for example, has earned an average return on equity of 40.3% over the past five years, almost twice the industry average. Its five-year return on investment average was 19.5% versus the industry’s 13.2%.

Other tech firms to score highly on these metrics include craft products marketplace Etsy, graphic design software champion Adobe, and from the UK, Kainos (KNOS), DotDigital (DOTD:AIM) and Quartix Technologies (QTX:AIM).

Microsoft is currently the largest single stake of highly successful UK tech funds the Allianz Technology Trust (ATT) and Polar Capital Technology Trust (PCT). Other names featuring near the top of their respectively portfolios include cyber security firm Zscaler, microchips maker TSMC (or Taiwan Semiconductor Manufacturing Company) and Micron Technology, a bellwether chips firm. Both funds also own Apple and Alphabet.

LONG-RUN TECH WINNERS

Veteran technology analyst Daniel Ives, of US-based investment firm Wedbush Securities, said that despite rotation and inflation fears compressing high multiple tech stocks, his long-term bullish thesis for the sector remained unchanged.

‘We believe this painful sell-off in tech has created the opportunity for investors to own the secular tech winners for the next three to five years,’ he observed. ‘Cloud and hybrid cloud environments represent one of the most transformational growth opportunities we have seen in our 20-plus years of covering tech stocks,’ the analyst said.

‘There’s nothing wrong with the fundamentals, and their earnings revisions are strong versus other sectors,’ concluded RBC’s Calvasina. ‘I don’t think this is the end of tech investing.’

Investors looking to position for the next two to five years, ‘there’s clearly a buy signal for some of these stocks based on their intrinsic value and their ability to grow and increase profits over time,’ agrees Advisors Capital’s Feeney.

‘It’s a clear opportunity for the longer-term investor,’ although Feeney accepts that it may be a ‘bumpy ride.’

DISCLAIMER: The author (Steven Frazer) owns shares in Allianz Technology Trust and Polar Capital Technology Trust, referenced in this article.

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