US Tech Sector Overvalued Despite October Slide

Ahead of results from Amazon and Alphabet this week, Morningstar analysts look at valuations in the tech sector

Brian Colello, CPA 22 October, 2018 | 8:45AM
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Apple Nasdaq

Despite recent falls in tech stocks, Morningstar analysts view the overall sector as slightly overvalued, with the Nasdaq still around 15% higher than the same time last year. Last earnings season saw a shakeout in the sector, with Facebook (FB) shares slumping.

So far this tech earnings season, Netflix (NFLX) stock has gained sharply on record subscriber numbers. This week sees including Amazon (AMZN) and Google parent company Alphabet (GOOGL) report earnings, with Facebook (FB) and Apple (AAPL) due the following week.

Before the sharp falls in the Nasdaq at the start of October, the tech index had been posting record highs in the third quarter, maintaining a level above 8,000 points. In the same period, Amazon and Apple became trillion dollar companies.

Away from the headline-grabbing product launches like the iPhone X, the single most important trend in technology remains the ongoing shift toward cloud computing, as enterprises move their computing workloads to pay-as-you-go business models that lead to greater flexibility, security, and cost savings. The shift has ramifications for dozens of stocks across Morningstar coverage.

Although the tech sector is overvalued today, we see a couple of undervalued names that are strong beneficiaries of cloud computing, such as (CRM). Independent of valuation, we still see winners among infrastructure-as-a-service vendors, such as Web Services, Microsoft Azure (MSFT), and Google.

Trade War Worries

The US-China trade war continues to add risk to technology investments; although companies have not been hit hard by tariffs just yet, we see many tech leaders assessing the current political situation and hoping for a satisfactory outcome. Apple's popular gadgets, such as the iPhone and Apple Watch, are believed to be exempt from the trade war for now, which we suspect is a relief to the technology supply chain as the vast majority of Apple's devices are assembled in China.

Any tariffs slapped on Apple products could have negative ramifications for dozens of technology stocks under our coverage, as lower demand for iPhones could weigh on revenue from many component suppliers that count on the smartphone titan as a large customer.

We continue to see M&A as a key theme in technology. We anticipate more software deals in the years ahead, as leading vendors like Adobe (ADBE), Microsoft, Salesforce, Oracle (ORCL), Workday (WDAY), and others branch out from their core product lines and tack on adjacent opportunities. Similarly, non-traditional software vendors like Cisco Systems (CSCO) and Amazon may make software-related deals as well, as software is becoming a more important portion of their enterprise offerings.

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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About Author

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