Head of Equity Strategy
Summary: Technology sentiment is as dark as when the dot-com bubble burst with many companies seeing their stocks decline by 50-90%. We take a look at some of these names, but which are also profitable, because it is during these periods when some of these companies can be bought at good risk-reward levels. We also take a look at Palantir's Q1 earnings release which disappointed on its Q2 revenue outlook sending the shares down in pre-market trading. Finally, we show how equity valuations are impacted from higher interest rates without any change to the underlying business.
Sentiment in technology stocks is plummeting
The tweet last Wednesday by David Sacks that “Investor sentiment in Silicon Valley is the most negative since the dot-com crash” tells you everything you need to know. The decline in high growth non-profitable companies, which we call bubble stocks, has been -69% since the peak in February 2021. Our bubble stocks basket has basically come back to the levels from before the pandemic. For some stocks it has been brutal such as Zoom, Teladoc, PayPal, and Pinterest, and we have seen that crypto related instruments are a high beta expression of liquidity preference and technology sentiment. The higher discount rate on cash flows are not only compressing equity valuations but also changing investors’ time preference demanding break-even faster than before.
Not all technology stocks are created equally with some of these fallen technology stocks actually being profitable. The list below is a list of US-listed stocks which are down more than 50% since 14 February 2021 and have a positive free cash flow yield; the list below is not meant as investment recommendations but highlighting companies with positive free cash flows yields that have been beaten down heavily. While many investors are suffering it is often during these periods of stress where investors can find very attractive long-term opportunities.
The list below shows that current constituents in our bubble basket.
| Name | Mkt Cap (USD mn.) | 12M Fwd EPS | 12M Fwd EV/Sales | Diff to PT (%) | 5yr return (%) | YTD return (%) |
| Lucid Group Inc | 30,271 | -1.09 | 13.2 | 97.0 | NA | -52.3 |
| Cellnex Telecom SA | 29,281 | -0.15 | 12.4 | 57.4 | 228.2 | -20.3 |
| Rivian Automotive Inc | 25,929 | -6.04 | 2.7 | 155.0 | NA | -72.2 |
| NU Holdings Ltd/Cayman Islands | 24,248 | 0.01 | 6.0 | 96.6 | NA | -44.2 |
| Seagen Inc | 22,722 | -2.58 | 10.3 | 30.2 | 97.4 | -20.2 |
| MongoDB Inc | 20,250 | -0.18 | 15.3 | 55.4 | NA | -43.4 |
| SenseTime Group Inc | 20,062 | -0.07 | 16.1 | 39.7 | NA | -14.5 |
| Unity Software Inc | 16,971 | -0.09 | 10.3 | 130.6 | NA | -59.9 |
| BeiGene Ltd | 16,673 | -10.48 | 6.0 | 116.9 | 288.1 | -45.6 |
| Argenx SE | 16,369 | -17.60 | 51.7 | 15.2 | 1,650.9 | -8.4 |
| Alnylam Pharmaceuticals Inc | 16,280 | -4.49 | 11.6 | 51.8 | 141.9 | -20.5 |
| Okta Inc | 16,054 | -1.06 | 8.0 | 112.0 | 336.9 | -54.3 |
| Brookfield Renewable Corp | 13,005 | 0.20 | 9.9 | 8.3 | NA | 0.7 |
| Shanghai Junshi Biosciences Co Ltd | 12,664 | -1.09 | 26.6 | 34.1 | NA | 1.3 |
| Bill.com Holdings Inc | 12,616 | -0.37 | 13.9 | 98.9 | NA | -51.4 |
| Grab Holdings Ltd | 11,532 | -0.37 | 3.3 | 85.6 | NA | -57.8 |
| Plug Power Inc | 11,221 | -0.42 | 7.4 | 112.6 | 804.9 | -31.2 |
| Qualtrics International Inc | 10,464 | 0.03 | 6.4 | 101.4 | NA | -49.2 |
| Wolfspeed Inc | 10,000 | -0.02 | 9.7 | 45.7 | 254.9 | -27.6 |
| Robinhood Markets Inc | 8,823 | -1.07 | 8.2 | 45.2 | NA | -43.0 |
| Novocure Ltd | 7,653 | -0.54 | 12.9 | 40.6 | 494.9 | -2.5 |
| SentinelOne Inc | 7,253 | -0.71 | 13.0 | 89.9 | NA | -48.3 |
| Affirm Holdings Inc | 7,097 | -1.82 | 3.7 | 143.7 | NA | -75.2 |
| Avalara Inc | 6,890 | 0.02 | 6.8 | 57.6 | NA | -39.3 |
| Procore Technologies Inc | 6,777 | -0.70 | 8.6 | 61.0 | NA | -37.5 |
| Kingdee International Software Group Co Ltd | 6,700 | -0.05 | 7.4 | 60.7 | 365.1 | -36.9 |
| Confluent Inc | 6,605 | -0.69 | 9.1 | 101.2 | NA | -68.9 |
| Guidewire Software Inc | 6,450 | -0.16 | 7.1 | 44.6 | 26.5 | -32.0 |
| Biohaven Pharmaceutical Holding Co Ltd | 6,365 | -6.39 | 6.2 | 74.8 | 312.7 | -34.5 |
| Gitlab Inc | 6,254 | -0.91 | 12.4 | 73.3 | NA | -51.3 |
| Elastic NV | 6,092 | -0.25 | 5.4 | 90.8 | NA | -47.0 |
| 10X Genomics Inc | 5,804 | -0.79 | 7.8 | 85.6 | NA | -65.6 |
| Smartsheet Inc | 5,625 | -0.59 | 6.4 | 52.8 | NA | -43.6 |
| Samsara Inc | 5,625 | -0.24 | 7.8 | 148.9 | NA | -60.7 |
| Monday.com Ltd | 5,550 | -2.85 | 8.7 | 87.8 | NA | -60.0 |
| Ginkgo Bioworks Holdings Inc | 4,810 | -0.20 | 9.3 | 243.2 | NA | -67.4 |
| Asana Inc | 4,752 | -1.24 | 8.1 | 112.7 | NA | -66.5 |
| Ascendis Pharma A/S | 4,730 | -7.71 | 41.5 | 114.1 | 200.0 | -38.2 |
| Guardant Health Inc | 4,008 | -4.56 | 7.3 | 211.2 | NA | -60.7 |
| Intellia Therapeutics Inc | 3,608 | -5.79 | 56.5 | 187.3 | 234.5 | -59.8 |
| Aggregate / median | 464,083 | 8.7 | 86.7 | 271.5 | -44.9 |
Palantir down 11% on outlook miss
Palantir is another very popular technology and growth stock that was IPO’ed in late 2020 which has seen it share price collapse to below $10 last Friday from as high as $45 in January 2021. The big data analytics company with prominent US government contracts reported Q1 results that were in line with estimates growing revenue 31% y/y in Q1 and still delivering an operating loss. However, it was the Q2 revenue guidance of $470mn vs est. $487mn that caused investors to sell shares in pre-market taking the shares down by 11%. The operating margin is improving but judging from the market reaction investors want to see it improving faster per our discussion of equity valuation dynamics related to discount rates (see section below).
Discount dynamics on equity valuation
The venture capital investor Bill Gurley said in late April that entire generation of entrepreneurs and technology investors will learn equity valuation the hard way and that the “unlearning” process could be painful, surprising and unsettling to many, and that he anticipates denial. Equity valuations like interest rates have had one direction only culminating in late 2020 and early 2021. But with rising interest rates and inflation the entire equity valuation game is changing and investors will demand business models that can break-even faster than before.
To get a sense of what the US interest rate move is doing to equity valuations let us look at a very simplified example. We have a company (no debt and no non-operating assets), growing revenue at 20% p.a. for 10 years with a NOPAT (net operating profit after tax) margin of 20% with a reinvestment rate of 10% per incremental revenue. The equity risk premium is 5% and in the first period the risk-free rate is 0.5% (equivalent to the US 10-year yield in 2020). The present value of those future free cash flows including the terminal value (the present value of continuing value) is $1,359 equating to a 1-year forward free cash flow yield of 1.6%. What happens to this company if everything is unchanged except for the risk-free rate moving from 0.5% to 3.2%? The value of those future cash flows drop to $831 and the equity valuation (1-year free cash flow yield) goes to 2.6%. The drop in equity value is equivalent to 39% for a 2.7%-points move in the risk-free rate which equates to an equity duration of 14x.
Anyone that knows equity valuation dynamics understand the importance of continuing value (terminal value). The dynamic that is amplifying the moves in equity valuation when you have a large correction in technology stocks is that technology investors are beginning to cut their expectations for the long-term outlook for margins and reinvestment rate etc. so the upward move in interest rates are amplified through several factors in the modelling of the present value of future cash flows.
2024: The wasted year
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
