As I expected weeks ago, tech stocks have rolled over.
That could mean a second dot-com bubble is ending in a dot-bomb bust. On the other hand, it might just mean that some good things are on sale, like when hockey sticks go on sale with the spring thaw.
The twin catalysts for the move are the re-opening of the economy and rising interest rates. The first means there are value stocks now providing, well, value. The second means there’s competition for investor money. A 10-year bond rate at 1.54% is higher than the average 1.5% dividend rate of the S&P 500.
The more speculative the rise was, the harder the fall has been. Growth is out of favor. But even rising earnings aren’t saving tech stocks, as investors demand more value from growth and pay less for earnings than before.
This week, I visited the bargain bin. I looked at the numbers and prospects for nine tech investments, trying to separate those worth buying from those you should pass on. Tech stocks with rising earnings should come back quickly once their price-earnings ratios fall into line with the new fashion. Those without earnings will have a harder time.
- Microsoft (NASDAQ:MSFT)
- Facebook (NASDAQ:FB)
- ServiceNow (NYSE:NOW)
- Palo Alto Networks (NASDAQ:PANW)
- Twitter (NASDAQ:TWTR)
- Electronic Arts (NYSE:EA)
- Bitcoin (CCC:BTC-USD)
- Fastly (NASDAQ:FSLY)
- Fluent (NASDAQ:FLNT)
Tech Stocks: For Microsoft, Too Good Is Never Enough
First on this list of tech stocks is Microsoft. Microsoft is firing on all cylinders, but the stock still looks expensive.
Microsoft opened for trade Feb. 26 at about $231 per share. That’s a market cap of $1.73 trillion on estimated fiscal 2021 revenue of $164 billion.
There’s nothing wrong with the company. But as the market turns toward value Microsoft doesn’t provide it. The price to earnings ratio is near 35x. A 56 cent per share dividend that once seemed generous now yields less than 1%.
Microsoft is as essential as government in a cloud-based world. President Brad Smith said it took 1,000 Russian engineers to hack the Solarwinds network monitor and make Microsoft customers vulnerable. This was an act of cyberwar, and Microsoft is on the front line. Microsoft is also faced with government demands for it to police the Web’s content, including the legitimacy of images.
Microsoft’s global cloud is now a fully realized profits juggernaut. At the end of December, it had $112 billion in unrealized revenue, about half of which will come in over the next year. Gartner (NYSE:IT) says its analytics software is miles ahead of the competition in vision and execution. Its new Viva platform, inside Microsoft Teams, can organize corporate armies of at-home workers.
Microsoft will use new datacenters and offices to push corporate computing off clients and into the cloud. It plans to do the same for their free time with xCloud, which puts its Xbox gaming system inside a browser.
Smart moves like this have analysts continuing to pound the table for the stock. All 23 following it on Tipranks have it on their buy lists. Their average one-year price targets are 21% ahead of where it’s currently trading. You can buy Microsoft “on the dip” and look good in five years. I’m not selling my little stake.
Facebook Only Has First World Problems
While Microsoft sells for 35 times earnings, Facebook is selling for 26. The reason is a misunderstanding of Facebook’s business, and its power. It’s why I bought Facebook shares during the tech wreck.
Free doesn’t matter in the West. But in Africa, in South Asia, or in Latin America, Facebook’s free services are a lifeline to the world and its markets. If that were threatened the world would be in trouble, not just Facebook.
In 2020, during a global recession, Facebook managed to grow its revenue by 21% at scale. It also brought one-third of this revenue to the net income line, an even better performance than in 2019. That’s net income of $29 billion, $10.09 per share, on revenue of $86 billion. The average price target for Facebook stock at Tipranks is $341, 33% ahead of where it is now.
This is possible because Facebook owns its cloud data centers. Facebook has a capital budget of $15 billion per year, more than most phone carriers, but negligible long-term debt of $10 billion. Credit operating cash flow of over $37 billion last year. At the end of 2020 Facebook had $62 billion in cash.
Facebook content comes from users. It’s free. This angers politicians and media companies. Facebook tries to massage their egos without changing the business model. Its “agreement” with Australia to “pay” for “news” isn’t a capitulation. It’s just being read as one by governments, and media companies, that want its money.
Facebook’s fight with Apple (NASDAQ:AAPL) over “data tracking and privacy” may be a headline in Cupertino. In Africa or India, the data tracking is your phone listing. Being found means you exist. It’s not a “privacy violation.” It’s part of the service.
In short, Facebook is an essential set of services Facebook has built for cash. It can change the nature of those services, and its business model, by pushing software into its network. It doesn’t have to charge a dime, to anyone, for any of this. It’s a model other Cloud Czars want to abandon.
As they do, Facebook has the free web to itself.
Why I Swapped out Salesforce for ServiceNow
During the tech wreck I decided to swap out of Salesforce.com (NASDAQ:CRM) and take a flyer on ServiceNow.
Why would I swap these tech stocks? It’s the law of large numbers. During 2020 Salesforce had revenues of $17.1 billion, $3.8 billion more than in 2019. During 2020 ServiceNow had $4.5 billion in revenue, just $1 billion more than the year before. Which company grew faster? It was close, but the answer is ServiceNow.
To keep growing, Salesforce now provides database application software across a host of business categories. It’s playing in the major leagues. Its pending purchase of Slack (NASDAQ:WORK) for $27.7 billion places it in direct competition with Microsoft and Alphabet (NASDAQ:GOOGL) in cloud office applications.
ServiceNow began with a similar database technology but focused on the construction and management of digital services. It has yet to move far beyond that niche. It’s still signing alliances around office applications, like Microsoft Teams. ServiceNow will control the workflow, Teams the collaboration. These are still believed to be separate at ServiceNow.
For tech investments, I bet the jockey more than the horse. That used to mean buying a founder, like Salesforce CEO Marc Benioff. No longer. What you’re looking for today is a proven manager with a vision and the skills needed to execute. That’s Bill McDermott. He’s been in database applications for two decades. He jumped to ServiceNow in 2019 from SAP (NYSE:SAP), where he was the first non-German CEO. He has forgotten more than many of his rivals know. Also, he still has some tread on his tires. He doesn’t turn 60 until August.
McDermott also knows about strategic acquisitions. His first at ServiceNow was Element AI, a Canadian developer of artificial intelligence applications co-founded by Yoshua Bengio. I met Bengio at the 2019 Heidelberg Laureate symposium. Attaching artificial intelligence structures to ServiceNow’s database-driven digital applications is, in my view, brilliant.
Smaller companies like ServiceNow carry greater risk than big ones like Salesforce. They have richer valuations. In this case it’s a price to sales ratio of 24, even after its recent fall, against just 13 for Salesforce.
You want to balance risks and rewards across your portfolio. On the growth side of mine, I decided ServiceNow is a better choice for me than Salesforce. I think it has more upside. But you can’t go wrong with either one.
Palo Alto Networks Needs Talent at the Bleeding Edge of Security
Even after dropping $25/share recently as stock fashions changed, Palo Alto Networks opened Feb. 26 worth twice what it was a year ago.
The company lost $142 million, $1.48 per share, on revenue of over $1 billion during the quarter ending in January. But it calculated $1.55/share in non-GAAP net income after backing off stock-based compensation, acquisition-related costs, and other charges.
As I’ve written before, Palo Alto is a leader in cloud security. But the crown hangs heavy. It takes an enormous investment to stay ahead of the bad guys, as the SolarWinds hack attests. This is no longer a game of cops and robbers. It’s war by another name.
To stay in the game, Palo Alto must be alive to “new algorithms, new concepts and new threats” that can not only lead to hacker success, but vendor failure. That doesn’t just require coding skills. It requires financial and strategic skills as well.
That’s where CEO Nikesh Arora, once chief business officer at Google and, later, number two at Softbank (OTCMKTS:SFTBY), comes in. He recently created a vehicle whereby employees can invest only in Palo Alto’s cloud and AI security. This keeps the talent happy and provides a route to new equity.
Arora needs to keep equity flowing not just for today’s talent, but for talent he might buy. The $156 million purchase of Bridgecrew shows what’s both possible and necessary.
Bridgecrew was founded in 2019, has just 49 people, and its open-source scanner Checkov (attn: Trekkies) is just a year old. But it has brought leading-edge customers like Robinhood, Databricks and Lending Home to its platform. Getting it now means Palo Alto won’t be competing with it later.
If you’re buying Palo Alto stock, you’re betting on Arora’s savvy, his ability to see the future of his field and get there ahead of other companies. Based on the track record that is a good bet.
Twitter is Lowering the Heat, Expanding the Business Model
Twitter wants to turn down the temperature. Analysts and politicians are cheering it.
Since the start of 2021 shares are up 42%. The gains aren’t down to financial results. The company lost $1.14 billion in 2020, on revenue of $3.72 billion. After adjusting for losses related to COVID-19 the loss was just 4 cents per share. It’s expecting revenue of around $1 billion for the current quarter.
During the most recent quarter Twitter launched a service called Birdwatch, trying to crowdfund the search for misinformation on the platform. It’s testing a “review your tweet” feature aimed at ending “rage-tweeting,” when people get mad at a post and attack the person posting it.
CEO Jack Dorsey says 80% of Twitter use is outside the U.S. The company claims to be taking a tough line in favor of speech and while it may have law on its side, it doesn’t have power. India’s government, for instance, forced Twitter to ban critics of its agriculture policy after threatening to imprison employees. India is technically a democracy. Most countries aren’t.
Dorsey wants to grow his user base by 20% this year. Much of that gain will have to come from places where the government is even more ham-handed than India.
Twitter has been on an acquisition spree and the result promises new paid business models. It wants users to pay for “Super Follows” from celebrities, competing with Patreon. It’s offering paid newsletters against SubStack podcasts against Spotify (NASDAQ:SPOT). This has kept the stock price high. “Will you be forced to pay for Twitter this year,” however, is not a headline the company wants to see.
My problem is Twitter has made promises before, without performing. Its best year was 2019, when it earned $1.46 billion, $1.87 per share. Revenue growth in 2020 was just 7%.
I’ll recommend Twitter when it shows consistent profits. In the current market of tech stocks, promises are cheap. It’s performance that matters.
Is Electronic Arts the Next GameStop?
Game publisher Electronic Arts is still growing, and its stock price is up 33% over the last year. But some are starting to worry. Are publishers going to be disrupted like Gamestop (NYSE:GME), this time by cloud gaming?
So far, EA sees cloud gaming as just another revenue stream. The company’s cloud play is its EA Play subscription service. Microsoft offers EA Play on its Xbox cloud gaming service, Ultimate. EA Play drew 3 million new subscribers during the December quarter. It now has 18 million.
The subscription revenue, however, is still a small part of EA’s total. Sales of game software still dominate. Making the turn is crimping profits. For the December quarter EA earned just $211 million, 72 cents per share, on revenue of $1.67 billion. For the same quarter of 2019 it earned $346 million, $1.18 per share, on revenue of $1.59 billion.
The EA strategy has been built on sports games, but it’s on an acquisition binge. During 2020 it paid $1.2 billion for Codemasters, which makes racing games. It also paid $2.4 billion for Glu Mobile, which makes mobile games.
By licensing its games through all platforms, including Alphabet’s Stadia and Sony’s (NYSE:SNE) Playstation Network, EA hopes to play the clouds off against one another as online play replaces consoles.
The danger is that as cloud gaming grows, from $500 million last year to $7.25 billion in 2027, clouds could gain in power at the expense of publishers. The biggest cloud provider, Amazon (NASDAQ:AMZN), just announced a cloud gaming service called Luna in September.
The best protection game publishers have against the cloud is the cost of game production. It can now cost much more to produce and maintain a high-quality game than any Hollywood movie.
But the threat is there. Publishers of books, music and entertainment thought they were protected against the clouds, too. Why do investors of tech stocks think gaming will be any different?
Bitcoin Is the Global Index of Fear and Greed
Bitcoin has taken over from gold as the global index of fear and greed.
It’s an index of fear because the quantity of Bitcoin is limited. It’s an index of greed because it’s portable, living only inside computers and used only through the Internet.
Thus, there has been a second run on Bitcoin, even bigger than the one in late 2017 that took it to nearly $20,000. On Feb. 22, Bitcoin was trading at over $57,000, representing 61% of the cryptocoin market and a market cap of over $1 trillion. On Feb. 26, however, it was at about $47,000.
The run began in November with the price near $13,000. It has been helped by an endorsement from Tesla (NASDAQ:TSLA) CEO Elon Musk. Musk put $1.5 billion of Tesla’s cash into Bitcoin and said the company would start taking it as payment for vehicles.
Tesla is estimated to have the second-largest corporate collection of Bitcoin. The largest is that of Microstrategy (NASDAQ:MSTR), a software company that has taking on debt to buy Bitcoin and was worth $9 billion, up 150% since 2021 started, on Feb. 22. By Feb. 26, however, that was $7 billion.
The latest rise had big banks like JPMorgan Chase (NYSE:JPM) considering Bitcoin as an inflation hedge. Goldman Sachs (NYSE:GS) fears smaller fintech competitors are getting into Bitcoin and could leave them behind. Intercontinental Exchange (NYSE:ICE), parents of the New York Stock Exchange, has a unit called Bakkt going public through a SPAC, VPC Impact Acquisition Holdings (NYSE:VIH). Bakkt plans to roll Bitcoin and other alternative forms of value, like loyalty points, into a single wallet app. Starbucks (NASDAQ:SBUX) and Microsoft are among the investors.
The long game is to have wallets like Bakkt be used for all kinds of transactions, disrupting the credit card industry. Visa (NYSE:V) and MasterCard (NYSE:M) currently take 3% of transaction volumes to pay for “settlement,” the cost (and risk) of moving money between merchants and consumers after a transaction.
To cut these costs, Federal Reserve chair Jerome Powell is talking up a “digital dollar” that would reduce settlement costs as Bitcoin does but be stable enough to be useful.
Bitcoin is a poor vehicle for solving settlement problems because it’s volatile and energy inefficient. The real threat is a “stablecoin,” like the Chinese Digital Yuan, that can hold its value within an instantly settled transaction.
If the digital Yuan takes flight in international trade, that’s when the alarm bells will go off. Bitcoin is just the canary in that coal mine of tech stocks and it’s breathing hard.
Fastly Shares Are Searching for a Bottom
When the market’s fashions change, it doesn’t matter what you do. Your stock is going down and it’s going down hard.
Fastly, for instance, offered stellar results in its fourth quarter and full year report. Revenue of $172 million was 51% ahead of last year. Operating cash flow losses of $19 million were far below the previous year’s $31 million. There was over $63 million in the bank at year-end.
These numbers would have looked stellar a year ago, or even three months ago. But the market wants profit, it wants value. Since its fourth quarter release came out on Feb. 17, Fastly stock is down 26%.
Fastly got a ratings upgrade from Oppenheimer analyst Timothy Horan right before the stock’s fall, after “channel checks” indicated record volumes and fast take-up for its “compute@edge” service. He thinks the company should trade at multiples like Cloudflare (NYSE:NET), which trades at over 50 times its annual revenue.
The excuse for Fastly’s fall is that the outlook wasn’t as positive as analysts hoped for. The company expects to lose 9-13 cents/share in the current quarter, which is close to its adjusted loss of 9 cents for the fourth quarter.
Fastly’s market should continue to grow quickly, with or without the pandemic. Tech stocks like Fastly are going to benefit from a rise in edge computing. Since buying Signal Sciences last year, a network security company, Fastly can assure that these services are secure.
Fastly stock should be one you watch closely among tech stocks, seeking a bottom you can buy. There’s growth here, and there’s opportunity for larger players. Vast new markets are going to develop at the network edge over the next few years as the Machine Internet becomes real.
Right now, most Fastly contracts are for short-term connections on behalf of people. Over time they’re going to become long-term contracts on behalf of devices. Fastly has a vast future ahead of it. Young growth investors should seek a way into it.
Fluent Was Pumped, Now It’s Being Dumped
Last up on this list of tech stocks is Fluent. Shares in Fluent, which calls itself a “performance marketing agency,” were up 45% for 2021 on Feb. 23, at about $7. Seen from the pandemic bottom in mid-March they’re a home run, up 367% since last March 15.
But if you’re sitting on profits, I warned it may be time to bounce. In pre-market trading on that date Fluent fell nearly 10%.
At its Feb. 23 price Fluent had a market cap of about $590 million. Revenue for the first three quarters of 2020 came to $250 million. If it hits estimates for the full year when it reports March 11, total revenue will be $330 million. In 2019 revenue was $281 million. When you’re growing at 18% you don’t need to show a profit, but Fluent had one. It’s $1.5 million so far, 1 cent per share, and the estimate for the fourth quarter is 6 cents.
Fluent has $44 million in debt on $77 million in tangible assets, according to the third quarter balance sheet. The vast majority of its assets are intangibles, including $165 million in goodwill. Net operating cash flow through the first three quarters was $13 million.
Fluent’s secret sauce is an algorithm, built from a database of user experiences. It uses this to generate sales and other actions for its clients. The home page’s biggest endorsement comes from Scentbird, which sells perfume by subscription.
The data comes from a set of websites Fluent owns, like The Smart Wallet, which offers finance “stories” like you’ll see hiding inside regular news sites. Many of the sites are from Winopoly, an 8-employee shop it bought half of last year. Winopoly was founded by Luciano Rammairone, a Staten Islander who has been in the lead generation business for over 20 years, starting with the CollegeBound Network.
Bryan Shealy, who did an analysis of Fluent last year, calls Winopoly’s sites “spam web sites.” They exist to collect user data, and then flood those addresses with e-mail marketing pitches. Fluent’s job is to collect and tease out patterns from this data and use it to drive sales for its clients.
The result, even Fluent CEO Ryan Schulke admitted on a conference call, is that Fluent’s margins are falling. He acknowledged the falling margins even before the Winopoly deal. Hard to see that they’ve improved.
Fluent got a boost from investors of tech stocks because, with the Winopoly deal, its numbers look good. But those are short-term numbers, not long-running relationships. The stock also got a boost from pandemic fashion, business continuing with people stuck at home.
This is a stock that’s going to fall to Earth. If you have a profit, take it.
At the time of publication, Dana Blankenhorn directly owned shares in AMZN, MSFT, FB and NOW.
Dana Blankenhorn has been a financial and technology journalist since 1978. He is the author of Technology’s Big Bang: Yesterday, Today and Tomorrow with Moore’s Law, available at the Amazon Kindle store. Write him at email@example.com, tweet him at @danablankenhorn, or subscribe to his Substack https://danafblankenhorn.substack.com/.