Do technology growth stocks that are reasonably valued exist?

Do technology growth stocks that are reasonably valued exist? by Michael McKenna
Technology stocks are getting more and more expensive as investors are intensifying their bets on the online economy. But is it possible to find technology companies with a good mix between expected sales growth and attractive valuation?

US technology stocks have been superior during the rebound touching recently new all-time highs. We wrote back in early May why investors should consider increasing the exposure to online companies and provided a large inspirational list of stocks. However, US technology stocks come in many shapes and colours with some being extremely expensive on many different valuation metrics. We call this group ‘bubble stocks’ and in mid-May we highlighted which metric to choose and which stocks we considered to be bubble stocks. In yesterday’s equity note on ‘work-from-home’ stocks we highlighted that some of these stocks had very high expectations discounted in their share prices as the valuation was stretched.

Today we asking a different question. Is it possible to still find technology companies that are expected to grow sales fast over the coming three years but still have a reasonable valuation? In the table below we highlight 25 stocks which have these characteristics. We have chosen the stocks based on the best mix between sales expectations the next three years and a good free cash flow yield relative to that sales growth. The selection universe covers all major exchanges in the developed world and covers the industries across internet retailing, interactive media & services, software, IT services, entertainment and semiconductors.

Name Industry Mkt. Cap (USD, mn.) Est. Sales growth (%) FCF yld. (%) Return YTD (local, %)
Ubisoft Entertainment SA Entertainment 9,439 22.6 10.3 11.7
QUALCOMM Inc Semiconductors & Semiconductor 100,276 14.2 6.7 2.6
Baidu Inc Interactive Media & Services 41,832 9.6 10.6 -4.0
Alibaba Group Holding Ltd Internet & Direct Marketing Re 606,886 25.7 3.6 6.7
VMware Inc Software 64,002 11.9 5.7 0.6
NetEase Inc Entertainment 60,009 11.7 5.4 43.6
Capgemini SE IT Services 18,694 7.9 8.6 -8.3
Enphase Energy Inc Semiconductors & Semiconductor 5,845 30.0 2.6 78.6
Lumentum Holdings Inc Communications Equipment 5,456 8.8 7.0 -8.1
Leidos Holdings Inc IT Services 13,246 11.1 5.2 -4.1
Proofpoint Inc Software 6,080 17.2 3.9 -7.6
Vipshop Holdings Ltd Internet & Direct Marketing Re 13,610 8.9 6.3 42.8
ASM International NV Semiconductors & Semiconductor 7,181 7.1 8.5 27.1
Facebook Inc Interactive Media & Services 667,270 17.6 3.7 14.0
Lenovo Group Ltd Technology Hardware, Storage & 6,743 5.6 17.1 -16.8
KLA Corp Semiconductors & Semiconductor 29,245 10.7 4.7 6.9
Fortinet Inc Software 21,714 15.7 3.8 25.8
Take-Two Interactive Software Inc Entertainment 15,937 11.5 4.4 14.2
Arista Networks Inc Communications Equipment 15,841 6.6 7.0 2.9
RealPage Inc Software 6,675 12.3 4.0 21.6
Qorvo Inc Semiconductors & Semiconductor 12,417 7.5 5.7 -6.6
GoDaddy Inc IT Services 12,589 10.2 4.4 11.3
Palo Alto Networks Inc Software 21,550 17.4 3.1 -3.4
Dropbox Inc Software 9,355 12.2 4.0 26.4
Adyen NV IT Services 42,781 65.2 1.4 72.8

Source: Bloomberg and Saxo Group
* The sales growth figure is the average yearly sales growth rate over the next three years. Free cash flow yield is measured as 12-month trailing free cash flow relative to the enterprise value.

The basket has an average sales growth rate per year of 15% the next three years and a free cash flow yield of 5.9%. S&P 500 has significantly lower expected growth rates and a free cash flow yield of 4.7%. So this basket does represent a better growth to valuation balance than what you get in the general equity market. The basket is up 14% year-to-date (in local currency) on an equal-weight basis. It’s also positive to observe that the basket is well-diversified across many different technology industries. As we are repeatedly saying on our morning podcast investors should reconsider adding Chinese ADRs (shares listed on US exchanges) as it comes with a higher risk due to the pending US bill to enable the US government to force a delisting of Chinese companies on US exchanges if they don’t comply with the new supervision and accounting framework.

The key risks to this basket are technology regulation, an escalation in the US-China trade war, lower economic growth due to a slower recovery post the COVID-19 pandemic, the companies do not meet analyst expectations, and finally higher operating costs eating into the free cash flows.

Topics: Equities Technology USNAS100.I Facebook Inc

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