Large Cap Tech has been an important piece of the move in the S&P 500 over the last month, rallying 10.5 percent to the index’s 7.1 pct gain. That got us to wondering both how this sector’s valuation looks now and where analysts’ earnings estimates have gone since the most important companies here reported Q3 numbers. For the purposes of today’s analysis, we will be looking at the Tech sector as well as Amazon/Tesla (technically Consumer Discretionary names) and Google/Facebook (Communication Services).
Here are current valuations based on 2022 earnings estimates:
- Large Cap Tech Sector: 26.8x (using S&P data)
- Amazon: 67.6x
- Tesla: 146.8x
- Google: 26.6x
- Facebook: 23.8x
- Note: S&P 500 at 21.3x 2022 earnings estimates
Comment: when it comes to valuing the Tech sector and “Big Tech”, there are 2 distinct approaches:
The first is traditional: sustainable earnings growth creates higher-than-market multiples. The Tech sector is expected to earn 70 percent more in 2022 than 2019, almost double the improvement in S&P 500 earnings power over the same period (+39 pct). Google and Facebook are also expected to show roughly a double in earnings power by 2022. Those are strong enough results, in our opinion, to justify 24x – 27x multiples when the market is trading for 21x.
Then there is Amazon and Tesla, with their 68x – 147x multiples on out-year earnings. As we recently wrote, these are not stocks so much as they are long dated call options on tech-based disruptive innovation. Both companies have theoretically huge addressable markets and strong competitive advantages. Their price-earnings valuations may look ridiculous, but they don’t trade on investor confidence in 2022 earnings. Rather, their valuations rise and fall with incremental success or failure in disrupting the global auto industry or ecommerce and cloud computing.
Takeaway: large cap Tech sector valuations are pretty much where you’d expect them to be if you exclude the “option stocks” (Tesla and Amazon). The group is not, in our opinion, dramatically overvalued. The one exception may be Tesla but, as we often write, one shorts it at one’s peril. Selling uncovered call options is always a risky strategy.
Now, let’s look at where 2021/2022 earnings estimates have gone over the last 30 days since this includes any new information contained in Q3 financial reports.
Positive revisions (ranked highest to lowest) and 1 month price return:
- Tesla: estimates up 10.6 percent for the current year (to $6.04/share) and +9.7 pct for 2022 (to $7.92/share).
One month return for TSLA: +48.1 pct
- Google: estimates up 7.7 percent for the current year (to $108.69/share) and +5.3 pct for 2022 (to $111.87/share).
One month return for GOOG: +6.6 pct
- Microsoft: estimates up 4.7 percent for the current fiscal year (to $9.20/share) and +4.0 pct for the 2023FY (to $10.51/share).
One month return for MSFT: +14.3 pct
- Apple: estimates up 1.1 percent for the current fiscal year (to $5.74/share) and +3.2 pct for the 2023FY (to $6.14/share).
One month return for AAPL: +5.3 pct
Negative revisions and 1 month price return:
- Amazon: estimates down 22.5 percent for the current year (to $40.94) and -22.4 pct for 2022 (to $51.60/share).
One month return for AMZN: +6.1 pct
- Facebook: estimates down 1.5 percent for the current year (to $13.93/share) and -11.7 pct for 2022 (to $14.24/share).
One month return for FB: +2.6 pct
Takeaway: there is a decent correlation between higher analysts’ earnings estimates and stock performance over the last 30 days for these 6 names. On its own, that is not surprising. In the context of Tech/Big Tech continuing to power US large caps higher, however, it is notable. As much as we are in the part of the cycle where economically sensitive businesses see incrementally better earnings expectations, Tech can also fit that bill. When it does (MSFT, TSLA this quarter for example), these stocks can still work.
This is the reason we always say “never underweight/short Tech”; these companies have earnings leverage just like any other and when their business models “click” it comes out in full force and markets respond accordingly. We maintain our even-weight recommendation on Tech.