The past month hasn’t been a good one for investors in FAANG (FB, AAPL, AMZN, NFLX, GOOG) and other major tech stocks. FAANG stocks were down an average of about 5.5% while popular recent IPO Snap Inc. (SNAP) is down 16.4%. So what caused this decline? Let’s take a deeper look as we continue to step towards financial fluency.
Although there are differing opinions, it largely seems that this decline was a result of the growing concern that tech stocks have runaway valuations. FAANG stocks account for just 13% of the S&P 500 value but attribute to 40% of the overall gain in the markets in the past year. A key spark to the decline in tech was the result of a report from Goldman Sachs CIO Robert Bouroujerdi that discussed how Facebook, Amazon, Apple, Microsoft, and Alphabet have added $600 billion to their market cap – that’s equivalent to the entire GDP of Hong Kong!
This caused algorithms which parse through news instantaneously to sell off tech stocks; this rapid selling eventually panicked retail investors who also sold off. While it appears that these tech stocks have leveled off and have found new levels of support, it is still anyone’s guess. In any case, tech stocks will be the spotlight of this upcoming earnings season. With earnings reports coming out in late July, it is important for investors to weigh this risk/reward before making an investment decision.
Investing Requires We Step Back
It is important when investing to take a step back and look at the bigger picture. Being worried because your Apple stock declined 5% is short-sighted if you have owned it for the past year. Why? Because Apple is up 25.6% year to date even after this decline.
This pullback or correction may have put investor worries about the rapidly growing valuation and possible over-valuation at ease. Looking at the company in a big picture view, we see a tech giant with roughly $215 billion a year in revenue and $46 billion in profit. More importantly, Apple has an absolute cash hoard of $257 billion. This gives them a huge balance sheet to work with for activity to grow the company even more. They can acquire large companies to expand into other markets. Assuming a 30% acquisition premium, Apple could buy Netflix and Tesla for cash and still have about $90 billion in cash left over.
Ultimately, cash is king.
Why Tech Stocks are Highly Valued by Investors
Let’s take a closer look at financial ratios as they play an important role in achieving financial fluency. One ratio investors can look at to gauge what investors are willing to pay based on the performance of a company is the Price to Earnings ratio (P/E ratio). P/E ratios vary a lot by each industry but technology is one industry that have very high P/E ratios. Of major tech, Apple comes in on the lower end with a 16.8 P/E ratio and Netflix coming in on the high end of just over 193. This means that for every $1 the company profits, investors are will to pay $16.8 for equity in Apple.
In contrast, we can see that other industries, such as industrials, have incredibly low P/E ratios. This is a combination of expected growth (or lack thereof), investor sentiment for a given industry, and investors’ willingness to “overspend” for a particular stock in contrast to the general market.
Overall, tech stocks have been performing very well in recent years which may give reason to be wary. On the other hand, there’s still massive growth potential in autonomous vehicles and virtual reality. It’s a toss up really – because how much is that next big thing worth?
Be sure to download the Rapunzl App to see how the community thinks tech will fare! By surrounding yourself with a greater understanding of the markets, you can continue to step closer to financial fluency.