US Tech Sector Still Overvalued, say Analysts

Ahead of earnings season for US tech stocks like Facebook, Amazon and Apple, Morningstar analysts look at the opportunities in the sector

Brian Colello, CPA 12 July, 2018 | 3:32PM
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Facebook Data Scandal

Tech stocks have had an impressive run over recent years and Morningstar equity analysts view the tech sector as slightly overvalued today, but less so than in the fourth quarter of 2017 and first quarter of 2018 as global markets have eased.

The single most important trend in technology remains the ongoing shift toward cloud computing, which we think is having ramifications on dozens of stocks across our coverage. We continue to see several undervalued names with healthy cloud computing exposure, such as four-star rated Microsoft (MSFT) and four-star rated (CRM). In short, both startups and enterprises, in efforts to reduce the high fixed costs associated with running on-premises IT hardware and software, are shifting more and more workloads to infrastructure-as-a-service, or IaaS, vendors, such as Amazon's (AMZN) Web Services, Microsoft Azure and Google (GOOGL).

In turn, IaaS vendors, along with "software-as-a-service" vendors are seeing tremendous growth while legacy IT vendors face ongoing headwinds. In SaaS, Adobe (ADBE) and Microsoft have been especially adept at transitioning to the SaaS model, as selling subscription software, rather than charging for upfront licenses, have expanded their customer bases. Oracle (ORCL), for one, has been relatively slower to react, in our view, albeit with some signs of optimism at times.               

Perhaps the most newsworthy items in technology over the past few months have been Facebook's privacy, data security, and regulatory struggles. Cambridge Analytica gained access to data on a reported 87 million Facebook (FB) users, casting a spotlight on the details of data captured, maintained, and shared by the social network, along with how Facebook uses such data to monetise its business. Separately, Europe recently passed its General Data Protection Regulation, which strives to standardise data capture, privacy, and distribution requirements for businesses as well as set guidelines to enable citizens to better understand their rights associated with user data.

Facebook Should Weather the Data Storm

Finally, as part of the debate around Facebook's user policies, Apple’s (AAPL) Worldwide Developer Conference highlighted several new features embedded within its Safari browser and iOS operating system that will strive to protect user data, restrict browser tracking, and allow users to set limits to their screen time and interactions in certain applications. While we anticipate that Facebook will weather the storm around increased near-term data scrutiny and note that the stock has bounced back in recent weeks after a Cambridge-related dip, data security and privacy will continue to be hot topics for debate among several tech titans.

Another ongoing trend within technology remains M&A. In the second quarter, two notable deal announcements were Adobe's bid to enter into commerce by acquiring Magento and Microsoft's $7.5 billion valuation of developer community Github. We anticipate more and more software deals in the years ahead, as leading vendors like Adobe, Microsoft, Salesforce, Oracle, Workday (WDAY), and others continue to branch out from their core product lines and tack on adjacent opportunities. Similarly, non-traditional software vendors, like Cisco (CSCO) and Amazon, may make software-related deals as well, as software is becoming a more important portion of their enterprise offerings.

We believe that the ability to provide customers with additional software offerings leads to a more loyal customer base and raises customer switching costs, which underpins our view of software leaders’ competitive advantages.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Alphabet Inc A2,178.16 USD-1.34Rating Inc2,151.82 USD0.25Rating
Apple Inc137.59 USD0.17Rating
Cisco Systems Inc42.94 USD2.92Rating
Facebook Inc A193.54 USD1.18Rating
Microsoft Corp252.56 USD-0.23Rating
Oracle Corp68.63 USD2.37Rating Inc159.65 USD2.60Rating
Workday Inc Class A165.99 USD0.89Rating

About Author

Brian Colello, CPA  is a senior stock analyst with Morningstar.