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Game Over for Tech Stocks

Written by Briton Ryle
Posted June 12, 2017 at 9:04PM

Tech stocks have been absolutely crushing it over the last few months. Flash memory maker Micron Technology (NASDAQ: MU) was a $24 stock at the beginning of March. Last week it hit $33 — a 37% gain. 

Another chip company, Nvidia (NASDAQ: NVDA), was as low as $95 on March 6. Last week's high was $168, good for a 76% gain... in three months. 

Tesla's (NASDAQ: TSLA) three-month gain from lows to highs was an even 50%. 

I guess the fact that Amazon (NASDAQ: AMZN) isn't technically a tech stock (it's consumer discretionary) explains why it was *only* up 20%. China's version of Amazon, Alibaba (NYSE: BABA), is clearly twice as good, if that 40% run is any indication...

I suppose you could look at these big runs higher in valuation and think, "Wow, the future must be amazing for these companies." And really, the future is bright. Electric cars are selling faster than expected and may well hit a critical mass point sooner than anticipated. Online retail is clearly dominating.

But that's the story for these high-flying stocks. There are also numbers that have to be considered — numbers like forward price-to-earnings (P/E) ratios, price-to-earnings growth (PEG) ratios, and free cash flow. 

Now, story and numbers go hand in hand. That is, a tech stock needs a good story. There has to be a good reason to think whatever the company is pursuing now is going to be huge in the future. But how much are the stories worth? Because there's always a chance it won't be huge. Plenty of great stories fail to make the final cut. Numbers are how you measure the risk of success and failure.

Story and numbers have to be in some kind of balance. But what does that actually look like?

What's Your Story?

In theory, the more certain you can be that a company's tech is the wave of the future, the more you can pay for the stock.

Take a company like Nvidia. It dominates the graphic chip market. And it is on the verge of dominating the driverless car chip market and the artificial intelligence chip market. It has been crushing earnings estimates and raising guidance for over a year. The forward P/E for Nvidia is 42.

That's expensive, absolutely. But it's not stupid expensive. It's possible to make a compelling argument that future revenue and earnings will justify the current price of the stock. 

So how do we reconcile the valuation on Apple (NASDAQ: AAPL)? After all, at ~13, Apple's forward P/E is just a fraction Nvidia's. Plus, it is has ~$250 billion in the bank and pays a much nicer dividend. In other words, its numbers are way better than Nvidia's.

The problem is Apple's story isn't nearly as good as Nvidia's. What, investors are gonna pony up a rich premium for the stock when the story is simply an endless upgrade cycle for the iPhone? "Oooo, this year's camera is so much better than last year's..."

Yeah, no. Just not as exciting. 

Investors are also wondering if Apple's story is actually about the future, or if it is only about the present. In other words, can it get better than it already is?

Apple has been the best-performing company basically ever. What's the upside? That it continues to execute flawlessly and stay the best company ever? It doesn't seem likely...

Nokia was the biggest cell phone company just 10 years ago. And Blackberry was a pretty big deal, too. Before that, Hewlett-Packard and Compaq made pretty good computers. Hewlett-Packard now just sells printers, and I don't even know what happened to Compaq. IBM sold its ThinkPad laptop division to Lenovo. 

The speed with which cutting-edge devices can turn into commodities or simply go obsolete can make your brokerage account spin. So I don't find it surprising that Apple remains cheap. The numbers tell you that investors see risk. 

Then there are cases where both the numbers and the story have gone bat-crap crazy. Any guesses?

Yeah, Tesla. 

"That Don't Make No Sense"

Tesla currently has a forward P/E of -396. Yeah, that's a negative. I can't fully explain what it even means here.

Investors have bid Tesla up to a $60 billion valuation. It sold something like 76,000 cars in 2016, and it lost money on every single one. Ford (NYSE: F) sold nearly $2.5 million cars in 2016, made about $8 billion in profit, pays a nice dividend... and is valued at $44 billion.

In the words of John Turturro: 

that don't make no sense

How can we possibly make any sense of Tesla's valuation? Well, there are batteries. If Tesla can really lower costs on batteries, it solves one of the biggest problems we have, not just for cars, but for the future of renewable energy. It will need that part of the story, too. Because the challenge of ramping its electric car production from 76,000 to 2 million is considerable. It will take years. And those years will likely all be money-losing years. 

The numbers have overshot the story by so much, it boggles my mind. It actually hurts to think about it. Fortunately, there are days like this past Friday...

Look Out Below!

Friday, June 9, 2017, started off pretty normal. All the tech stocks were up. About noon, they all started to sell off. A little after noon I tweeted this: 

tweet

It was a big reversal. Tech stocks got hammered across the board, especially those big momentum names: Amazon, Netflix, Micron, Nvidia, and, yes, even Tesla. 

There was no "reason" for this big sell-off. There was no big news that dropped them. But I can tell you why it happened...

The numbers for these tech stocks have gotten out of sync with the stories. These stocks are too expensive. It's the fault of the machines, the algo-driven trading computers that drive 70% of trading volume every day. The stock prices have rallied because there has been no resistance. All the machines are trading together in the same direction. 

This will change. Consider Friday a shot across the bow. There have been a couple shots across the bow over the last few months. These are also called distribution days. And they mean the big money is taking some loot off the table. 

It's time to think and act defensively. I have some more thoughts on this, which I will get into on Wednesday.

Until next time,

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Briton Ryle

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An 18-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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