Following the Nasdaq’s biggest one day downwards move in two years, it is clear that the babies are being thrown out with the bathwater, turning the sector into a contrarian, stock picker’s paradise. This is because the two biggest drivers of the market in the short-term are greed and fear, with fundamentals only asserting themselves over a long-term period of around three to five years.
This is exactly what is happening right now, as it is the narrative-driven stocks which flew to the moon on borrowed wings that are crashing the hardest.
The pandemic has changed the world, but not nearly as investors were promised, and the reassertion of real life – as well as inflation triggered by rampant money printing – is causing demand to wobble.
All of this is perfectly normal, but when one trades on 10x+ EV / revenues and loses a lot of money or trades on 50x+ PER, this rapidly becomes a real problem. This is because these multiples are already pricing in a scenario where very high growth continues for a long period into the future due to the high level of confidence that the market has in the company.
This is why even a small miss on revenues and profits can cause an outsize negative reaction, as it is the confidence of the market that is unravelling. The fundamentals don’t change that much, but the multiple that the market is willing to pay for the revenues or earnings can unwind extremely quickly as confidence evaporates.
The most glaring example of this is Netflix, which reported its first-ever decline in users – mostly due to cutting off Russia, but that did not stop the shares from cratering by 35% in a single day.
Teledoc (one of ARK Innovation’s favourites) found itself in a similar situation last month and almost halved in a single day.
The list of pandemic darlings that have fallen by half or more is long, and also includes a large number of SPAC IPOs that were priced on 2025 revenues, as well as those seen as the pioneers of the metaverse like Roblox and Unity.
The one company that continues to defy gravity is Tesla, but I suspect that when Mr Musk again fails to deliver his autonomous robotaxis, the valuation may crack.
On the flip side, the companies with real revenues and profits – as well as a secular story behind them – are going to be the most defensive in this environment.
For example, semiconductors are already proving to be defensive, as they have real revenues and profits and multiples that are generally not nearly as high, meaning that they have a much smaller correction to make.
Similarly, the very large companies like Google, Apple, Meta Platforms, Alibaba and Tencent which also have real fundamentals and much more reasonable multiples will correct, but they will correct much less, making them defensive within the sector.
One thing that is also very likely to happen is that the good companies whose valuations are getting hit hard will over-correct, which means that good assets will end up on sale at attractive valuations.
For the last few years, the market has been awash with liquidity, meaning that companies with spurious businesses and technologies have been able to raise capital at valuations that make no sense. As interest rates rise and liquidity dries up, everything is being hit indiscriminately, meaning that the shares of good companies will be on sale at large discounts despite there being no change to their fundamental outlook.
This is where fundamental analysis and stock picking come into their own, as the right choices are likely to be rewarded with outsize returns for those that can sit tight for three to five years.
Consequently, if I was running a portfolio that had to be in technology, I would be looking at an allocation to the cheaper end of the semiconductor sector, as well as some of the big cap names for their defensive characteristics, along with a few of the babies that have been thrown out with the bathwater.
Babies I am thinking about include Unity (file under: “picks and shovels of the metaverse“), Palantir and Peloton, but I have yet to pull the trigger on any of them.
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