Overvalued FANG Stocks Slump

US technology stocks fall back towards their fair values after Thursday's market rout, which saw the Nasdaq fall 5%

Dave Sekera, CFA 4 September, 2020 | 9:31AM
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Wall Street, New York

After hitting a new all-time high on Wednesday, the Morningstar US Market Index dropped 3.58% Thursday, the largest single daily decline since June 11. While single-day declines of such magnitude are generally unusual - over the past decade, there have been only 18 times the market has sold off this much in a day. Even though there doesn’t appear any single catalyst for this significant sell-off, we are not surprised by this market pullback – indeed more than half of the stocks we cover are overvalued as of September 2. Since we began calculating this price/fair value metric in 2007, there have been only a few other times that our fair value indicator has been this overvalued.

The bulk of the sell-off occurred within the technology sector, which dropped 6.08% today. In our view, after being the best-performing sector thus far this year, technology is the most overvalued space within the index. According our price/fair value metric, the median stock in the tech sector was 1.24 times overvalued on September 2. Not only is it the most richly valued of all the sectors we cover, but neither it nor any other sector has ever traded at such a high price/fair value since we started calculating this metric in January 2007. Within the tech sector, for US-listed companies that we rate, there are 56 firms that we believe are overvalued and have rated 1 or 2 stars (out of 5 stars); whereas there are only 11 stocks that we think are undervalued and rate 4 or 5 stars.

There was no newsflow on Thursday that appeared to serve as the catalyst to the sell-off. Economic metrics released this morning were either slightly better than expected or in line with consensus and continue to indicate that the economy is healing. Although still higher than in April, the number of reported new daily cases of Covid-19 remained on a generally downward trend since mid-July. No new data was released regarding the vaccines currently in or entering Phase III trials. We are past the second-quarter earnings season, so there were no negative earnings surprises. It is too early in September for companies to start providing warnings if they are going to miss their third-quarter estimates. The market movement just seemed to be one of those days in which selling beget more selling and few investors were willing to step in to start buying until prices had dropped substantially.

Apple share price

Apple Still Overpriced

As an example of some of the companies we think are overvalued, we currently rate Apple (AAPL) with only 1 star. Our fair value estimate for the stock is $71 per share; even after falling 8% today, the stock closed at $120.88, resulting in a price/fair value of 1.7. Similarly, our fair value for Adobe (ADBE) is $350, as compared with the market’s closing price of $507.80.

The pullback on September 3 has brought stocks back closer to being fairly valued for long-term investors. While the market remains overvalued, we continue to see significant value within other sectors and companies. For example, the price/fair value for the energy sector is only 0.62. Since 2007, the only other times this sector has appeared so undervalued was during the market rout earlier this year and during the depths of the global financial crisis in late 2008. Based on our outlook for energy demand to recover post-pandemic and our forecast for oil prices to rise to $55 per barrel by the middle of the next economic cycle, we see significant value in this sector. For example, within the energy sector, for US-listed companies we rate, there are 53 firms that we believe are undervalued and have rated 4 or 5 stars; whereas, there is only one stock that we think is overvalued and have rated 2 stars.

While our price/fair value metric has helped identify periods in which the market has swung too far one way or the other, we caution that it not a tool to try to time the market. Valuations can remain high or low for prolonged periods before they revert to normalised levels. We do think it is a useful gauge among many to help long-term investors balance risk and reward within their portfolios.

 

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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

Dave Sekera, CFA  is a senior securities analyst with Morningstar.