Growth tech stocks may not be in the forefront for investors right now. Especially after Friday, when stocks posted their worst percentage decline in more than a year and their worst raw point decline in nearly a decade. But there is still a lot of room for stocks to rebound, particularly growth tech stocks.
Everyone is concerned about rising rates. After Trump was elected, the reflation trade was a popular one. Investors expected Trump’s tax cuts and fiscal stimulus to reinvigorate inflation. But that trade quickly faded as inflation just failed to pick up.
Fast forward a year, and inflation has finally arrived at the party. The January Jobs Report just showed the biggest wage increase for U.S. workers since 2009.
That is a bad thing for stocks. Inflation means more rate hikes, and more rate hikes means rising fixed income yields. But one of the things propping up equities is that they are cheap relative to bonds. If bond yields rise, then the spread between those yields and the earnings yield compresses. The more that compresses, the less cheap stocks look.
That argument makes sense. Until you look at the numbers.
The 10-Year Treasury Yield is at 2.86%. The forward earnings yield for the S&P 500 is 5.59%. That means there is still a 273 basis point spread in yields in favor of equities.
In other words, stocks still have room for valuations to expand before they start looking expensive relative to bonds. Consequently, I think stocks will rebound from this sell-off. In particular, I think tech stocks will rebound because that is where all the earnings growth is coming from.
Here are my three favorite tech stocks on this recent drop.
Big Growth Tech Stocks To Buy #1: Facebook Inc (FB)
The first of the big growth tech stocks is Facebook Inc (NASDAQ:FB), which reported blowout quarterly numbers last week. Those numbers sent FB stock up to $195, an all-time high. But the recent weakness in tech stocks has caused FB to drop back below $190.
That doesn’t make much sense. FB has an exceptionally strong growth narrative supported by a very reasonable valuation.
Firstly, the company is beating this drum of community safety and engagement over profits, and that is a good thing. The company is pivoting to focus on higher-quality engagement versus higher-quantity engagement. That means less ads, but it also means more value per ad since Facebook is the only place in the world where advertisers can get 4 billion eyeballs. Consequently, average revenue per user should go up dramatically in the long run, while average cost per user should stay relatively constant.
That means higher margins on big revenues, which equals huge earnings.
Secondly, there are multiple untapped revenue growth opportunities ahead for Facebook. Those opportunities include Watch (Facebook’s over-the-top media platform which is trying to dominate the short-form, 15-minute professional video market), Marketplace (Facebook’s online garage sale which connects buyers and sellers from across the globe), Workplace (Facebook’s enterprise solution which brings in healthy recurring revenue), Messenger (Facebook’s messaging platform which has more than a billion users and is increasingly used to connect businesses with customers), and many others.
When investors say “what’s next” for Facebook, they can point to all those opportunities. That gives Facebook a really long runway for big growth.
Thirdly, FB stock is dirt cheap considering its robust growth potential. We are talking about a company that is expected to grow earnings around 30% per year over the next 5 years. FB stock is trading at 26.5-times this year’s earnings, meaning the stock’s price-to-earnings/growth (PEG) ratio is under 1.
The S&P 500, though, is trading at a much richer PEG ratio of 1.3.
All in all, FB is a “buy the dip” stock. This recent dip is no different. I’m buying.
Big Growth Tech Stocks To Buy #2: Alibaba Group Holding Ltd (BABA)
Chinese e-commerce and cloud giant Alibaba Group Holding Ltd (NYSE:BABA) also reported blowout revenue numbers last week, but investors focused on margin compression which led to a rare earnings miss. BABA stock dropped. Then the sell-off was exacerbated by the broad sell-off in equities. Overall, BABA stock dropped from $205 to below $190.
This is a golden buying opportunity.
Firstly, BABA stock is cheap. Just like FB, this is a company which is modeled to grow earnings around 30% per year over the next several years. But BABA stock trades at just 36-times this year’s earnings. That gives BABA stock a PEG ratio of 1.2, below the market average PEG ratio of 1.3.
Secondly, the reason for the post-earning sell-off in BABA stock is short-sighted and lacks scope. Investors are hyper concerned with the fact that EBITDA margins compressed by a full 7 percentage points during the quarter. That is a huge decline, and the biggest in recent memory, but margin compression isn’t anything new for BABA.
Alibaba is like Amazon.com, Inc. (NASDAQ:AMZN) in that margins fluctuate from quarter to quarter based on growth fueled investments. And those investments always end up resulting in super-charged top and bottom line growth.
In other words, Alibaba invests big to grow big. So what is important from the quarter isn’t that margins compressed. Its that the full-year revenue growth guide was hiked from 51% to 55.5%. That means long-term big growth is here to stay, thanks to near-term investments.
Thirdly, Alibaba has exposure to all the markets an investor wants exposure to. The company operates the biggest digital commerce operation in the world’s hottest retail market (China). Alibaba also operates the fastest growing cloud business in the world. Both of those businesses are looking to expand globally, implying the growth runway for this company extends out another 5-10 years, if not more.
Just like FB, cheap valuation and big growth prospects make BABA a “buy the dip” stock. This recent dip is no different. I’m buying.
Big Growth Tech Stocks To Buy #3: Paypal Holdings Inc (PYPL)
Just like Facebook and Alibaba, digital payments processor Paypal Holdings Inc (NASDAQ:PYPL) also reported blowout quarterly numbers last week. But those numbers were overshadowed by the announcement that eBay Inc (NASDAQ:EBAY) is phasing out Paypal as their primary payments processor.
The move came as a shock to investors and analysts. Paypal and eBay were viewed as a “together forever” situation. PYPL stock dropped steeply as a result. Its down around $78 now, versus a pre-earnings price of $85.
But the sell-off seems overdone.
eBay only represents roughly 13% of Paypal’s Total Payment Volume (TPV). And that number was 900 basis points higher just 2.5 years ago. In other words, eBay is a small portion of Paypal, and that small portion is getting smaller. According to management, when its all said and done, eBay will represent about 4% of Paypal’s TPV.
Also, eBay is Paypal’s slow-growth segment. PYPL’s eBay segment has grown at roughly a 4% clip over the past 10 quarters. The rest of PYPL’s business (the other 87% of TPV) has grown at a 23% rate over the past 10 quarters.
So if you dissect the part of PYPL’s business that will be affected by eBay phasing PYPL out, you realize that PYPL isn’t losing much value at all. They are losing a small, slow-growth part of their business. The net result should be a slightly smaller business with a much higher growth rate.
Overall, then, I think PYPL stock is a buy on this dip.
As of this writing, Luke Lango was long FB, BABA, AMZN, and PYPL.