Internet and Technology Sector 1H2017 Review: Are They Overvalued? June 21, 2017
US listed internet and technology stocks experienced a sharp reversal on 9 Jun 17. Asia markets followed suit the next trading day. Notably Tencent closed the day with a 2.5% decline and dragged down Hang Seng Index. The sharp reversal sparked overvaluation concerns from investment banks and sceptics. According to a report by CNBC, a combined market value of USD100 Billion was wiped out from 5 biggest technology stocks in Wall Street.
Are internet and technology stocks overvalued? Should we buy internet and technology stocks on a dip?
Concerns on the overvaluation for these sectors are warranted. On the technical side, Nasdaq 100 index is at its all-time high levels. Fundamentally, the First Trust NASDAQ-100-Technology Sector Index Fund (QTEC), which is an exchange traded fund that tracks the performance of NASDAQ-100-Technology Sector Index (NDXT), traded at a trailing price to earnings ratio of 25.08 as of 31 May 17. The sector is expected to grow its earnings at a rate of 16%, according to Bank of America Merrill Lynch. This will imply a PEG (Price/earnings to growth) ratio of around 1.57.
Separately, PowerShares NASDAQ Internet Portfolio exchange traded fund (PNQI), which aims to track the performance of the largest and most liquid US-listed companies engaged in internet-related businesses, traded at a price earnings ratio of 44 as of 31 Mar 17. Assuming these sectors can translate their 23% expected revenue growth into earnings, this will give the sector a PEG of 1.91.
Both sectors have PEG ratio of above 1.5. The internet sector, in particular, looks frothy and more so if you take into account the non-profitable internet companies. Investors should expect substantial correction if the sectors miss their growth expectations. Buying an exchange traded fund to track Nasdaq’s performance at current levels may not be optimal. Investors may want to be discerning and invest in companies with strong fundamentals within the sectors.
Some of these companies include Facebook, Alibaba, Netease and Tencent. They are the market leaders and are growing their revenues in excess of 40% YOY. Their businesses are cash flow generating and profitable. These factors are important as cash generated from operations can be used for research and development to improve their core product offerings. They can also pursue inorganic growth through acquisitions. Doing so will impose a higher barrier to entry for new entrants. These companies are also helmed by their founders, who demonstrated foresights, innovations, ability to monetise and execute their strategies.
|Companies||P/B ratio||P/E ratio (TTM)||5 yr Revenue CAGR(%)||Debt to asset ratio|
As of 20 Jun 17
It is worth noting that Facebook executives warned of a slowdown in its advertising revenue. Therefore, it is probable for the share price to correct further. Investors also need to be aware that earnings for Tencent & Netease are subjected to lifecycles of their gaming products.
Depending on your risk appetite, investors can still allocate a portion of their portfolio into internet & and technology companies that have the abovementioned traits while taking valuation into consideration. After all, a lot of these companies are Disruptors to the existing business models, while shaping the future and offering catalysts for earning growths.
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About the author
Chiang Jin Liang
Jin Liang is currently providing dealing services to over 8000 trading accounts and is part of the POEMS Dealing, the core in-house dealing department of Phillip Securities Pte Ltd.
Jin Liang believes in applying both fundamental and technical analysis in equities investing. He likes companies that can grow their earnings, stay relevant in an ever-changing landscape and focus on investor relations. Jin Liang frequently conducts educational seminars with the objective of imparting financial knowledge to the general public.
Jin Liang holds a Bachelor Degree in Electrical Engineering from Nanyang Technological University (NTU) and passed Level II of the Chartered financial Analyst (CFA) exam.