With the rise of interest rates (which still hover at relative historical lows), several financial pundits are claiming the tech sector is massively overvalued. Their logic stems from the mathematical opinion that tech companies for the large part have a majority of their actual earnings projected to take place 5-10 years out in the future. Thus, with higher interest rates, these future earnings are worth less now when discounted back by a higher interest rate.
Although there are some frothy names in the market trading at sky high price to sales ratios of 100+, this generalization has many holes. As a note, stocks like Snowflake and other recent IPOs look expensive no matter what interest rates are. A couple basis point move in the 10-year note doesn’t make SNOW go from cheap to overvalued??
For example, let’s take a look at perhaps one of my favorite stocks, Facebook FB. Despite constant government hearings and bad press, FB has been a machine. Its revenue growth has been consistently impressive despite their massive scale and market capitalization. In the most recent quarter, revenue growth proved to be reaccelerating in fact. With the reopening of America upcoming, FB is poised to massively increasing its advertising revenues from one of its best customer segment, Travel and Leisure.
From a valuation perspective, FB is trading at roughly 10 times sales and just under 30 times earnings. If one projects the next year’s growth in sales and earnings, the forward P/E falls below 20. Basic math suggests such metrics represent a company trading at a cheap valuation and nothing close to “extremely overvalued”. Also, let’s not forget FB’s massive cash pile (and no debt) which accounts for over $20 of the current share price (i.e., $299/share). Assuming FB could simply use this cash to buy back its own stock and reduce the overall share count, the trailing P/E metrics for the current day calculations would fall from roughly 30 to under 20.
Finally, no matter if one hates FB or loves it, their business model is enviable. They rake in advertising money from the sharing of content which is provided by others free of charge. FB also doesn’t need to make massive capital investments to keep their business going….heck they barely even need any employees.
I’ll leave you with one of my favorite figures when assessing a company…enjoy!
And take everything financial pundits say with a grain of salt!