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All hail the return of a stockpicker’s market in 2015 — at least for large cap tech. Note the enormous dispersion between the performances of outperformers such as Apple Inc. (AAPL.O) and Facebook Inc. (FB.O) and the middle of the pack – LinkedIn Corp. (LNKD.N) and Amazon.com Inc. (AMZN.O) and the also-rans such as Twitter Inc. (TWTR.N).
Source: Thomson Reuters Eikon
Apple in the lead
Of course, the best performer on the chart is also the largest constituent of the NASDAQ, making most owners of NASDAQ and S&P 500 index trackers feel rather smug. With recent declines for Twitter and LinkedIn, we thought we’d revisit the issue of valuation in these large cap stocks to try and get a sense for what’s “in the price.”
Source: Thomson Reuters
Questions abound
While it’s always impressive to hear about strong earnings growth, that isn’t actually what drives the share price. The share price is driven by new information, so right now we have Amazon on a market-implied five-year growth rate of 72.8%. Is this all due to expected increases in sales? No, Amazon’s management are pursuing a deliberate policy of market share gains, with the expectation that they’ll be able to lift prices further down the line. The debate over whether this is credible, particularly in market segments such as cloud infrastructure where Amazon isn’t the only big ugly player with deep pockets, remains unresolved.
What can be said with certainty, though, is that the market has already bought into this concept to some extent, as is evidenced in the high levels of anticipated growth. On the other hand, Apple assumes much more reasonable levels of growth at 10.1%. That still remains an incredible challenge for the world’s largest listed company, but given its own history of earnings growth and continued innovation you wouldn’t want to bet against them.
Between these two extremes lie other firms, but to my mind, the concerns should be most acute around the relatively unproven business models. LinkedIn continues to grow EPS and their business model is relatively mature, while there are some more fundamental reservations for Twitter.
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For Twitter, whose very name is now a daily feature of the English language, it is less clear on what basis the stock is trading on such a strong premium. (In old money, the stock trades on just under 80x earnings.) In addition to the challenges of valuation, the stock has an ARM (Analyst Revisions Score) score of 1. This means it is in the bottom percentile for North American stocks, driven by downgrades to revenue and EPS numbers and downgrades of broker recommendations.
Source: Thomson Reuters Eikon
Crowd moves
When you combine unappealing valuations with negative revisions, you tend to see some significant sell offs, as the “growth at any price” crowd starts to head for the exits. When this bull market does come to an end, and companies are expected to grow organically without being able to binge on cheap credit, you’ll want to be very confident in the earnings model. Even that won’t necessarily save you. Cisco Systems Inc. (CSCO.O) traded to over $80 in 2000; 15 years later, with far higher earnings, a share can be yours for under $30. That’s the nightmare of multiple compression as growth slows.
Source: Thomson Reuters
Hold your breath
So with the NASDAQ and other major indices trading at all-time highs, now is the time to think about the type of portfolio you want to hold. Anything with a very poor ARM score should be carefully scrutinized. Anything with breathless expectations and every move breathlessly reported by financial news networks — well, just be aware that no one rings a bell at the top.
In 2000, at least, there were places to hide. Old world stocks like financials or General Electric Co. (GE.N) were completely ignored in the frenzy for all things tech. Today the market looks expensive across the board, though we won’t get into the many and varied arguments on why the market isn’t actually so … over-priced. I’ll save you a lot of trouble – all the justifications for the current market valuations are some form of:“this time it’s different.
