There has been much consternation about technology stocks appearing overvalued. While it pays to be cautious, especially after a multiyear bull run in which the tech-heavy Nasdaq composite has outperformed the S&P 500 by 8% annually over the last five years, the following beliefs in this assertion are flawed:As technology companies are a homogeneous group, a statement that applies to a subset of technology businesses applies to all of them.
Consumer staples businesses unquestionably fall within the domain of “high-quality” businesses. They own valuable brands, generate eye-watering returns on equity, and convert a substantial portion of their earnings into free cash flow. However, these companies are not growing their earnings — and they haven’t done for a while. Because share prices are ultimately driven by earnings growth, this will affect the prospective returns investors can hope to derive from them.
An excellent illustration of this would be to contrast the performance of Unilever with Facebook over the last five years. In the case of Unilever, it trades on a blended forward price-earnings multiple of 19.5 times. However, its reported revenues have declined by 1% annually and its reported operating profit grew by only 2% annually in the last five years. If one places the valuation of Unilever in the context of its growth prospects, it trades on a P-E to growth multiple of a hefty 4.5 times.
In contrast to Unilever, Facebook trades on a blended forward P-E multiple of 22 times but has grown its revenues 37% annually and reported increasing profit 54% in the last five years. Even assuming growth in diluted earnings per share reduces to the mid-teens , this would place it on a PEG of 1.5 times, vs Unilever’s 4.5 times. Unlike Unilever, it does not feel the need to report non-Gaap figures, perhaps because the “as reported” numbers are “good enough”.
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