Is now the right time to invest in tech stocks?
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Stocks of technology companies were hugely popular with investors throughout much of the past decade. Their valuations seemed to consistently climb, benefitting from a strong economy, low interest rates and a shift towards the digital economy that boosted their businesses.
The COVID-19 pandemic only fueled their growth, with companies such as Amazon (AMZN), Meta Platforms (META) and Netflix (NFLX) seeing a surge in demand thanks to people spending more time at home. But as the economy looks to find its new normal and the Federal Reserve aggressively raises interest rates to curb high inflation, many of these tech darlings have fallen back to earth.
The tech-heavy Nasdaq Composite is down more than 30 percent so far in 2022 as of Nov. 1, the largest decline of the three major stock market indices. Longtime market leaders such as Meta, Amazon, Alphabet (GOOG) and Netflix are down even more. So should investors view the recent declines as an opportunity to find value in tech shares or as a warning sign of things to come?
Often the best time to invest is when prices have fallen and people are pessimistic about the near-term outlook. As legendary investor Warren Buffett has said, “The future is never clear; you pay a very high price in the stock market for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values.”
Here’s what to know as you consider investing in tech stocks.
Should long-term investors buy tech stocks?
With tech stocks getting pummeled so far this year, some investors may be on the hunt for bargains, but it’s hard to know if things will get worse before they get better.
With tech stock valuations more attractive than they were a year ago, long-term investors can start putting money into the sector, says Liz Young, head of investment strategy at SoFi. But given the volatile environment, she recommends investors “average in” over time to take advantage of more attractive prices she expects to see in the coming weeks and months.
Tech companies face a number of challenges at the moment including rising labor costs due to inflation, declining advertising revenues as the economy weakens and greater scrutiny of their valuations due to rising interest rates. “They’ve got headwinds coming from all directions right now,” Young says.
But still, Young says that investors with a time horizon of at least two years, and preferably longer, can start buying tech shares in a diversified way. She recommends using an ETF such as the Invesco QQQ Trust (QQQ), which tracks the performance of the Nasdaq-100 index.
(Here are some other popular tech ETFs to consider.)
Other investors have also found what they believe are attractive investment opportunities in beaten-down tech shares. The Dodge and Cox Stock Fund (DODGX), an actively managed mutual fund, initiated a new position in Amazon during the third quarter after researching companies with attractive fundamentals where investors’ expectations and valuations had declined. Amazon’s stock price has fallen more than 40 percent this year as of Nov. 1. The fund also holds stakes in Alphabet, Meta and Microsoft (MSFT).
How rising interest rates have hurt tech stocks
Shares of technology companies have suffered, in part, due to the rise in interest rates. Many tech companies have low or even negative earnings because their businesses are in the early stages and they’re investing heavily with the hope of future growth. As interest rates rise, investors prefer companies that generate real earnings and cash flow today and are less willing to pay up for companies that may or may not have earnings far into the future.
For example, online used-car dealer Carvana (CVNA) benefited during the pandemic as used car sales boomed and many physical dealerships were closed. In 2019, Carvana generated $3.9 billion in revenues, while in 2021 the company saw revenues jump to $12.8 billion. But despite the enormous growth, the company failed to generate a profit in either 2020 or 2021.
Carvana’s stock rose from a low of around $22 in March 2020 to more than $375 in August 2021 as strong revenue growth fueled investors’ expectations and record-low interest rates gave them few alternatives. Since Carvana’s August 2021 all-time high, the yield on a two-year U.S. Treasury Note has risen from about 0.20 percent to 4.5 percent. Over that same time period, Carvana’s stock has fallen about 95 percent to around $15 as of Nov. 1, 2022.
To be sure, there are tech companies that generate huge profits in the here and now, and some investors think the market has overly punished these cash cows alongside shares of more speculative issues.
Wally Weitz and Brad Hinton, co-chief investment officers of Weitz Funds, wrote in a recent note to clients that while higher interest rates are especially hard on fast-growing companies with little in the way of earnings today, several stocks have been punished that do generate earnings and cash flow.
“Many investors seem to have made the incorrect generalization that rapid growth itself is a negative in the new environment,” Weitz and Hinton said, adding that companies such as Alphabet “have lots of earnings today and will have even more tomorrow.”
The Weitz Value Fund owned shares of Alphabet, Meta and Amazon as of Sept. 30, 2022.
A closer look at FAANG stocks
In recent years, investors have come to refer to the largest tech companies as “FAANG,” with each letter representing each of the tech giants Facebook (now Meta), Amazon, Apple, Netflix and Google (now Alphabet). Many of these stocks have been hit hard in 2022 despite being profitable and having reasonably strong long-term outlooks.
Here are some key recent developments with each company including how each stock has performed so far in 2022.
(*Note: Share price data as of Nov. 1, 2022. EPS estimates from Yahoo! Finance.)
The parent company of Facebook, Instagram and WhatsApp has had a difficult year, with declining advertising revenue coming as it ramps up spending to build its vision for the Metaverse. CEO Mark Zuckerberg has said the company will focus on its most high-priority investments and he believes it will return to strong revenue growth in the future.
Year-to-date performance: -71.7 percent
EPS estimate 2023: $8.18
The e-commerce giant reported disappointing third-quarter results and issued a weak outlook for the fourth quarter. Growth at Amazon Web Services, the company’s cloud business, decelerated and its retail operations face challenges from the difficult macroeconomic environment such as high inflation and a strong dollar. The company says it’s focused on initiatives that will build a stronger cost structure going forward.
Year-to-date performance: -41.9 percent
EPS estimate 2023: $1.80
The iPhone-maker has been a relative standout among big tech companies in 2022, with its stock outperforming the broader Nasdaq Composite so far this year. In its most recent quarter, Apple posted record revenue and EPS results and believes it’s positioned well for a strong holiday quarter, though some analysts think the company could be impacted by broader macro uncertainties and currency headwinds.
Year-to-date performance: -14.8 percent
EPS estimate 2023: $6.30
The streaming giant benefited from people staying at home during the pandemic, but saw subscriber losses in the first half of 2022. In response, the company announced a new ad-supported option after saying for a long time that it would never have ads. In its most recent quarter, Netflix added 2.4 million net new subscribers and expects to add more than 4 million in the fourth quarter of 2022.
Year-to-date performance: -52.4 percent
EPS estimate 2023: $10.51
Advertising revenue at Google-parent Alphabet has also slowed throughout 2022, as its YouTube unit faces competition from TikTok and advertisers generally pull back on spending due to economic uncertainty. The company says it’s sharpened its focus on key priorities including new ways to monetize its YouTube Shorts product. Alphabet’s earnings have fallen as expense growth has outpaced that of revenue.
Year-to-date performance: -37.5 percent
EPS estimate 2023: $5.30
While tech shares have faced heavy pressure throughout 2022, some investors may be ready to give the beaten-up sector another look. If you’re buying individual stocks, be sure to research each company thoroughly before investing. Less experienced investors may want to consider a diversified approach by using an ETF that limits their exposure to any single company.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.