As markets once again plunged on Friday, something else was happening to many high-flying stocks such as Apple (AAPL) - Get Report: Their generally inflamed valuations were being brought down to earth.
It’s a trend worth watching because as the market see-saws between relief and panic from one day to a next, the underlying reality of the stocks is they were bid up to expensive levels coming into the current market rout. Now that valuations are coming down, thinking about how low they could go may be a clue to where stocks prices will bottom.
Consider Apple. From the end of August, just before the unveiling of the new iPhone 11 models and its new TV channel, “Apple TV+,” through the first half of February, Apple shares soared by more than 58%. The valuation of the stock in that time, on a forward price-to-earnings basis, surged from around 16 times projected earnings for the subsequent 12 months, to 23 times.
Putting a similar 16 times multiple on current estimates would yield a stock price of $225.60, a 21% haircut from here. Whether that happens depends on a number of factors, such as the ongoing shape of the COVID-19 disease’s spread, the course of election year politics, the global macroeconomic outlook, and, as always, this year’s iPhone hype cycle.
Consider some other potential valuation resets, based on a variety of valuation metrics. Enterprise authentication software maker Okta (OKTA) - Get Report isn’t profitable and may not be so till the year ending January of 2023. The preferred metric is a multiple of its projected sales for the next twelve months. That’s a fairly high 18.5 times, well above, for example, an older software name such as Microsoft (MSFT) - Get Report, which fetches just 8.5 times sales.
If one were to roll back Okta’s valuation to a recent low of about 16.5 times, like Apple, that could put the stock price back to where it was in September, around $105 per share, a further 14% fall from here.
Speaking of Microsoft, its own P/E multiple on forward earnings has zoomed for years now. Perhaps Microsoft, despite a recent cut in its outlook, will remain the safe port in the current storm, but not necessarily.
Microsoft currently fetches 26 times projected earnings for the next twelve months. That’s way down from 31 times before the recent market turmoil but also well above a mere 20 times at the end of 2018, when Microsoft’s projected revenue growth was actually higher. Cutting back to a multiple of 20 times for Microsoft would mean a stock price of $120, a quarter lower than the current price.
One of the most stunning tech gainers of 2019 was video advertising sensation Roku (ROKU) - Get Report, more than quadrupling in price. Like Okta, Roku is not yet profitable on a net basis, so it is evaluated on other metrics such as enterprise value (market cap plus net debt) divided by profit before the cost of interest, taxes, and depreciation and amortization, otherwise known as “EV to Ebitda.”
At a recent $99.40, Roku stock has lost all its gains since late September, but its EV to Ebitda is still almost 600 times, well above the 172 times it was at in September because its Ebitda outlook subsequently declined. Even without rolling valuation all the way back, a mere haircut to 300 times would cut the stock in half to $51.
Perhaps the most egregious recent run-up in valuation is Tesla (TSLA) - Get Report, whose stock has more than tripled since September even after recent declines. In that time, the stock’s EV to Ebitda has surged from 18 times to 30 times. If the stock were to now fall to that prior valuation, it would be a plunge of 60% in price.
It’s not just the flashier names that could take a pounding. Applied Materials (AMAT) - Get Report, the world’s largest vendor of chip-making equipment, and DRAM chip maker Micron Technology (MU) - Get Report, are not especially expensive relative to the broader market, trading at 13 times forward earnings per share and 12.5 times, respectively. But as recently as the summer, before investors started banking on a chip market turnaround, they traded at 11 times and 8 times forward earnings, respectively. Worries about the macro economy and the spread of Covid-19 could push both those valuations back to what they were when the outlook wasn’t as good.
And that offers an important final thought for all tech stocks. If the economic outlook suffers, it could hit estimates for revenue and profit, making the stocks seem even more expensive and leading to even more selling pressure. At that point, the possibilities offered here could look relatively rosy.