Market Beats

Tech Stock: To Buy or Not to Buy?

MioTech Team 2018-12-04

This report investigates the factors that drive tech stock prices and if investors look to growth in earnings or sales when evaluating a tech company.

The market has been dominated by the FAANG-tastic Five, tech titans that together accounted for well over 30% of the USD$2.7 trillion increase in the S&P500 in the past year. Since the beginning of 2016, FAANG stocks have propelled Nasdaq with record upon record. The 5 favourites, whilst going through one of their worst performances in recent months, still remain a go-to growth stock for investors.

But how do investors determine the value of a tech company? In valuation measures, price to earnings ratio is the most common metric to justify the valuation of a company or even a sector.  But you can’t paint technology companies with the same brush. They’re still at a loss-making, nascent stage with no clear signs of profitability. And yet, their stocks are often in the most demand. Why? Because of potential gains. To overcome this, investors use sales figures as a substitute to make a relative comparison against stock prices.

"To overcome this, investors use sales figures as a substitute to make a relative comparison against stock prices."

In our report, we dive into both sales and earnings of the 5 market dominating tech companies, Facebook, Apple, Amazon, Netflix and Google for the past few years, to find out which of the 2 barometers play a bigger role in affective stock price in the long term.

Taking Facebook as an example, we see a growing divergence between earnings per share (EPS) and sales during 4Q2014 to 3Q2015 indicated in the shaded area in the charts.

Source: Company Report

 

During that period, the EPS lagged behind sales growth. Moving forward, the EPS expanded at a growth rate in the range of 16%-29%, much higher than the low-teens growth in the sales.

To quantify, we calculate the two set of correlation of the EPS and sales per share related to stock price. Stock price and sales per share correlation was 0.97, which is slightly higher than the EPS’s reading of 0.94. We can conclude that the company’s sales are more correlated to Facebook stock price and ultimately, investors value sales numbers over earnings.

But while we see a strong relationship between sales and stock prices, it’s important to note that the promise of profits on growth stocks often go hand in hand with uncertainty and high risk. Notably, as of recent months, FAANG stocks have faltered, with Facebook and Apple plunging over 20%. Collectively, they lost more than USD$1 trillion in value from recent highs. What seemed like a safe bet and a bull market, is now turning bearish, leaving FAANG at precarious valuations.

 

In a bear market, investors would conventionally shy away from risk stock picks which begs the question, does sales per share still dominate price movements in the current market turmoil? We approach this with a qualitative analysis since data points in 2018 are limited.

Leveraging on AMI’s artificial intelligence brain, we assess the impact on stock price after the announcement of quarterly results on sales and net profit during 2018. Using Facebook again as an example, once the announcement was made in the end of October, sales as well as net profit showed correlations with stock price movements on the day of the event.

Source: Company Report

 

In addition, we found that sales posted a slightly higher correlation to the daily return on the same day the results were announced, showing higher scores than earnings. But it’s important to note that this was before October market routs.

Interestingly, during post trade war tariffs and stock market turmoil, Facebook’s earnings had greater correlations with stock price as compared to sales, echoing our views that investors are bearish, focusing on earnings growth during a market slump.

To further support the notion of investors looking to earnings to access risky tech companies, we take an even deeper dive into recently listed, early-stage tech companies. Looking East, we found that the stock prices of companies like Xiaomi, rose over 8% on the 22nd November on the backs of upbeat earnings but remained in-line with revenue growth. Looking West, Surveymonkey reported a less-than-expected loss of USD -0.01 in 3Q18 result against the market at an expected USD -0.05, in-line with expected revenue growth. Its stock price jumped 13% after the results.

“Deceleration in earnings growth or earnings below market expectation would lead to a shake-out in bets and trigger a selloff despite better-than-expected sales growth. ”

In conclusion, deceleration in earnings growth or earnings below market expectation would lead to a shake-out in bets and trigger a selloff despite better-than-expected sales growth. This implies that the underwhelming performance of tech stocks is predicted to continue during this bear market, and will take a little longer to return back to glory days until stock earning momentums improve.

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