Revenue shortfalls at Amazon.com (NASDAQ:AMZN) and Alphabet (NASDAQ:GOOGL) caused many to abandon tech stocks October 26. This put into question the continued dominance of the FANG stocks — Facebook (NASDAQ:FB), Amazon, Netflix (NASDAQ:NFLX) and Google — and big tech stocks in general on which the market’s rise this decade was based.
Buying the big tech stocks, particularly cloud names like Amazon, Google, Microsoft (NASDAQ:MSFT) and Apple (NASDAQ:AAPL), has been the way to riches over the last few years. Even with their recent collapse, the five largest cloud companies had a combined market cap of over $3.8 trillion.
So, is the thesis dead? No, but the cloud-and-devices era has matured. The big tech stocks are now the global economy’s incumbent economic powers as the owners of the infrastructure which is essential to the continued functioning of our current economy and society.
Big Tech Stocks: Our New Economic Overlords
The problem for investors is that the owners of incumbent infrastructure are supposed to act like utilities, with stable earnings and even dividends. The big tech stocks are still investing, with quarterly capital expenditures in what SRG Research calls “hyperscale data centers” exceeding $25 billion during the second quarter, led by the Cloud Czars.
There is every indication this spending continued into the third quarter, as Intel (NASDAQ:INTC), which is one of the primary data center suppliers, handily beat estimates on earnings, led by its data center business, where sales exceeded $6 billion.
Despite the continued investment, all the FAANG stocks are down over the last month. Apple stock is down 4%, Google and Facebook are both down 13%, and Amazon is down a whopping 19%. Even Alibaba Group Holding (NASDAQ:BABA), which dominates China’s cloud, is down over 16%.
Despite this the big tech stocks aren’t cheap. Amazon’s market cap of $784 billion is still more than three times its estimated 2018 sales of $234 billion. Alphabet’s market cap of $731 billion is almost 6 times its 2018 estimated revenue of $130 billion. The problem becomes, how should we value our new economic overlords?
The key to maintaining high capital spending is profitable growth, and while growth for these tech stocks is slowing, profits are accelerating. Amazon and Alphabet both handily beat estimates on profits for the third quarter.
This transforms the investment thesis for tech stocks from one based purely on growth to one based on profits. This is particularly true for the cloud-infrastructure companies.
The Bottom Line
The present panic will subside, and investors are going to get a chance to find new bargains, based on the big tech’s real growth prospects and earnings potential, which I like very much.
The company that has done the most to cross over from being valued based on growth to earnings so far has been Apple. Its price to earnings multiple of 19.7 is actually below the average for the S&P 500 — 22, despite a dividend that has nearly doubled in five years and a huge stock buyback program.
The bottom line is that you’ll soon be able to base investments on big tech stocks the same way other investments are evaluated — on earnings and dividends. And over the next five years those figures still look good. Once the market settles down I’ll be buying more tech stocks — particularly in the companies that provide the cloud infrastructure.
Dana Blankenhorn is a financial and technology journalist. He is the author of a new mystery thriller, The Reluctant Detective Finds Her Family, available now at the Amazon Kindle store. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing he owned shares in BABA, MSFT and AMZN.
