Big Tech - Who's Still Jumping In
How much willingness is left to buy tech stocks at current valuation levels?
Almost every investor, especially those who diversify, has benefited this year from the spectacular rise of Big Tech.
Since the beginning of this year, the total market value of the 'Magnificent Seven': Apple, Amazon, Google (Alphabet), Microsoft, Meta, NVIDIA, and Tesla, has surged a staggering USD 4.3 trillion to USD 11.25 trillion.
To put that into perspective, that USD 4.3 trillion is almost twice the total market value of the German stock exchange and one and a half times the market value of India. USD 4.3 trillion is also more than Japan's annual GDP. The surge is undeniably astronomical.
Afraid of heights?
But it is not without consequences. The realized and forward P/E ratios have risen to 58 and 40, respectively. This means massive profit growth is needed to justify current valuations.
Skyrocketing valuations come at a time when earnings growth of Big Tech has turned negative! While most investors focus on beats and misses, realized earnings also matter. Admittedly, the decline is partly due to the ongoing Covid crisis, which has disrupted many macro and earnings figures. Still, current valuation levels underscore the massive profit improvement that investors expect.
What about interest rates?
Another aspect that investors seem to overlook are rising interest rates. I attach great value to a discounted cash flow model to assess the direction of market valuation and stock prices.
For Big Tech stocks, and growth stocks in general, a relatively large portion of their cash flows and profits are realized further into the future. Hence rising interest rates should have a more profound impact on 'high-duration’ stocks, like Big Tech.
Based on other metrics, the valuation of tech stocks also went to the moon. Below are the price-to-sales ratios for U.S., global, and technology stocks. These require little elaboration.
The point I want to make is not that Big Tech cannot continue to rise. They can. Technology stocks are well-suited to reflect the (irrational) extrapolation of growth expectations. However, the willingness of investors to enter at these levels is declining. And since, in the short term, stocks are not so much driven by valuation but by supply and demand, this is where the risk lies. The demand for extremely expensive tech stocks may suddenly decrease. At that point, every investor WILL start to look at valuations!