Do technology growth stocks that are reasonably valued exist?
Head of Equity Strategy
Summary: In today's equity note we provide a basket of 25 stocks comprising of technology companies with a good mix of expected sales growth over the coming three years and an attractive valuation relative to those expectations and the market in general. The basket is well-diversified across many different technology industries and have a higher free cash flow yield than the S&P 500 but it also has higher expected sales growth rate than the general equity market.
US technology stocks have been superior during the rebound touching recently new all-time highs. We wrote back in early May why investors should consider increasing the exposure to online companies and provided a large inspirational list of stocks. However, US technology stocks come in many shapes and colours with some being extremely expensive on many different valuation metrics. We call this group ‘bubble stocks’ and in mid-May we highlighted which metric to choose and which stocks we considered to be bubble stocks. In yesterday’s equity note on ‘work-from-home’ stocks we highlighted that some of these stocks had very high expectations discounted in their share prices as the valuation was stretched.
Today we asking a different question. Is it possible to still find technology companies that are expected to grow sales fast over the coming three years but still have a reasonable valuation? In the table below we highlight 25 stocks which have these characteristics. We have chosen the stocks based on the best mix between sales expectations the next three years and a good free cash flow yield relative to that sales growth. The selection universe covers all major exchanges in the developed world and covers the industries across internet retailing, interactive media & services, software, IT services, entertainment and semiconductors.
|Name||Industry||Mkt. Cap (USD, mn.)||Est. Sales growth (%)||FCF yld. (%)|
|Ubisoft Entertainment SA||Entertainment||9,439||22.6||10.3|
|QUALCOMM Inc||Semiconductors & Semiconductor||100,276||14.2||6.7|
|Baidu Inc||Interactive Media & Services||41,832||9.6||10.6|
|Alibaba Group Holding Ltd||Internet & Direct Marketing Re||606,886||25.7||3.6|
|Capgemini SE||IT Services||18,694||7.9||8.6|
|Enphase Energy Inc||Semiconductors & Semiconductor||5,845||30.0||2.6|
|Lumentum Holdings Inc||Communications Equipment||5,456||8.8||7.0|
|Leidos Holdings Inc||IT Services||13,246||11.1||5.2|
|Vipshop Holdings Ltd||Internet & Direct Marketing Re||13,610||8.9||6.3|
|ASM International NV||Semiconductors & Semiconductor||7,181||7.1||8.5|
|Facebook Inc||Interactive Media & Services||667,270||17.6||3.7|
|Lenovo Group Ltd||Technology Hardware, Storage &||6,743||5.6||17.1|
|KLA Corp||Semiconductors & Semiconductor||29,245||10.7||4.7|
|Take-Two Interactive Software Inc||Entertainment||15,937||11.5||4.4|
|Arista Networks Inc||Communications Equipment||15,841||6.6||7.0|
|Qorvo Inc||Semiconductors & Semiconductor||12,417||7.5||5.7|
|GoDaddy Inc||IT Services||12,589||10.2||4.4|
|Palo Alto Networks Inc||Software||21,550||17.4||3.1|
|Adyen NV||IT Services||42,781||65.2||1.4|
Source: Bloomberg and Saxo Group
* The sales growth figure is the average yearly sales growth rate over the next three years. Free cash flow yield is measured as 12-month trailing free cash flow relative to the enterprise value.
The basket has an average sales growth rate per year of 15% the next three years and a free cash flow yield of 5.9%. S&P 500 has significantly lower expected growth rates and a free cash flow yield of 4.7%. So this basket does represent a better growth to valuation balance than what you get in the general equity market. The basket is up 14% year-to-date (in local currency) on an equal-weight basis. It’s also positive to observe that the basket is well-diversified across many different technology industries. As we are repeatedly saying on our morning podcast investors should reconsider adding Chinese ADRs (shares listed on US exchanges) as it comes with a higher risk due to the pending US bill to enable the US government to force a delisting of Chinese companies on US exchanges if they don’t comply with the new supervision and accounting framework.
The key risks to this basket are technology regulation, an escalation in the US-China trade war, lower economic growth due to a slower recovery post the COVID-19 pandemic, the companies do not meet analyst expectations, and finally higher operating costs eating into the free cash flows.