Even though the sell-off in big tech has reduced valuations to more tolerable levels for the high-flying tech names, some investors may want to diversify their growth tech holdings away from those most vulnerable to corrections.
Tuesday, tech continued to sell off, with the Nasdaq 100 down more than 3.5% late in the day. The index is down about 8% since Wednesday's close, just before tech investors seemed to have had a valuation epiphany. The NYSE FANG Index is down about 11.5% in that span, putting it into correction territory. Apple (AAPL) - Get Apple Inc. (AAPL) Report stock has been one of the most notable offenders, down 14%. It was trading at above 35 times next year’s earnings per share estimate, against an expected EPS compound annual growth rate of about 8% for the next several years, according to FactSet data.
Apple’s services businesses may have been benefiting from the stay-at-home trends posed by the pandemic, a dynamic that has powered many tech stocks this year to outperform value stocks by a wider margin than what was seen in 2000, just before the tech bubble burst. But other stocks exposed to at-home trends, like Nvidia (NVDA) - Get NVIDIA Corporation Report (data center and cloud) and Amazon (AMZN) - Get Amazon.com, Inc. Report (cloud and e-commerce) have also corrected substantial. These stocks do trade at more attractive multiples than they did pre-correction, but the bears aren’t exactly going into hiding quite yet. And one of the most pressing concerns, which seems to be a part of the correction, is that the massive uptick in demand for these services may be pulling too much long-term demand forward for the valuations to be justified.
Sure, Nvidia is one of them and so is Advanced Micro Devices (AMD) - Get Advanced Micro Devices, Inc. Report, both of which are neck-deep in the data center business, which powers the cloud. But other semi stocks that offer a growth element to one’s portfolio are not part of the song-and-dance around assessing what the at-home environment entails for the post-COVID economy.
Broadcom (AVGO) - Get Broadcom Inc. Report reported earnings last week and beat revenue and earnings per share estimates by 0.8% and 3%, respectively. The strong quarter, management and others have noted, was partly due to continued strength in 5G-related chip sales. The stock rose after earnings and held in nicely during the tech sell-off Friday. That was after the stock more than participated in Thursday's sell-off, as the stock fell 6% ahead of earnings. The stock only fell a bit more than 1% Tuesday, while the iShares PHLX Semiconductor ETF (SOXX) - Get iShares PHLX Semiconductor ETF Report fell more than 3%. Although the stock is usually less volatile than the average U.S. stock — it has a beta of 0.95 where less than 1 indicates low volatility — the strength in the shares clearly comes after strength in the fundamentals.
Broadcom trades at roughly 14 times next year’s EPS, whereas 15 times is the trailing 5-year high. Earnings are expected to continue growing, especially as 5G device sales volumes are expected to explode in 2021. 5G smartphone volumes are expected to double next year and growth rapidly again in 2022.
“They [Broadcom] should be one of the ones that also participates in 5G, a more connected world, automation,” Dan Eye, head of asset allocation and equity research at Fort Pitt Capital Group told TheStreet. Fort Pitt holds Broadcom’s preferred convertible shares, which offer a juicy dividend yield and turn into common stock in 2022. "Those are the types of names that nobody wants to talk about in this FAANG driven world,” Eye added.
But the point is not to pitch Broadcom.
Broadcom is a perfect example of a chip company with the scale to continue powering the world’s newest technology needs and growing earnings at least in the mid-to-high single digits in percentage terms on a sustained basis. It trades at a reasonable multiple, at least compared to other tech stocks, although those other stocks do have more powerful earnings streams. Long-term upside to earnings for a Broadcom always exists.
Qualcomm (QCOM) - Get QUALCOMM Incorporated Report is in the same camp, although it’s trading somewhat expensively, at 18 times earnings, against a recent average of about 14 times. Qualcomm is seen as a leader in 5G and a potential market share gainer.
Chip analysts at Mizuho wrote in a note including optimism on Qualcomm and Broadcom, "We continue to see opportunities in Auto/Industrial as valuations are attractive.” That comment also includes 5G players Qorvo (QRVO) - Get Qorvo, Inc. Report and Skyworks Solutions (SWKS) - Get Skyworks Solutions, Inc. Report. Revenue and earnings growth projections in 2021 reach above 20% for some of these names — Qualcomm is expected to grow revenue at above 25% year-over-year in the second half of 2021 -- driven by the new-and-improved devices. Growth is currently modeled to moderate considerably as the 5G cycle winds down in a few years. These product cycles serve as periodic tailwinds for chip makers. And the best and largest semiconductor players — Broadcom’s market cap is $140 billion and it’s working down its debt — can serve as one part of an investors’ growth portion of a portfolio.
One of the major downsides to the chip makers: the consumer-facing and industrial markets are somewhat economically-sensitive, which adds a layer of cyclicality to earnings, as do product cycles.
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