After “crushing it” during the novel coronavirus pandemic, high-growth tech stocks appear primed to stay winning during recovery mode. Assuming inflation worries do not get in the way. Why is inflation bad for this sector? It has less to do with inflation itself, and more to do with the raising of interest that typically follows it.
How is this bad for names in this category? Namely, it’s bad news when it comes to their valuations. Why? Higher interest rates mean higher discount rates. That is, the interest rate used to determine the future value of cash flows. Since fast-growing tech stocks are priced mainly on their earnings down the road, an increased discount rate makes it harder to justify rich valuations, such as the ones we see today.
That’s why the Federal Reserve’s possible response is being watched so closely by stock market participants. Yet, while inflation jitters have been running high so far this year, the “best case scenario” may be the one that plays out: that the recent rise in inflation is merely transitory. In other words, the increase in prices we’ve seen lately is due to pent-up demand and supply shocks from the post-outbreak reopening. That’s Federal Reserve Chairman Jerome Powell’s view. And, it’s a view shared by most in the investment management community.
If you find yourself on team transitory inflation as well, and believe that Fed policy isn’t about to do a 180, what’s the next move? Take a look at these seven fast-growing tech stocks. Each one could avoid valuation contraction, and continue to thrive, if interest rate fears dissipate:
- Bumble (NASDAQ:BMBL)
- CrowdStrike (NASDAQ:CRWD)
- Facebook (NASDAQ:FB)
- Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL)
- Nvidia (NASDAQ:NVDA)
- Palantir (NYSE:PLTR)
- Shopify (NYSE:SHOP)
Tech Stocks: Bumble (BMBL)
After going public in February, dating app operator Bumble has seen its shares take a tumble. In recent weeks, it’s partially bounced back, going from less than $40 per share, to around $55 per share today. But, it’s still down from its debut trading price ($76 per share).
What’s behind this? Two factors. First, concerns about the company’s future growth falling short of expectations. Second, the downward pressure applied to growth stocks since talk of inflation entered the conversation in February. Yet, as InvestorPlace’s David Moadel discussed on June 3, the market may be wrong in treating BMBL stock as a “show-me” story.
Concerns over its outlook notwithstanding, the company beat on expectations for the preceding quarter. Its base of paid subscribers continues to grow at a healthy clip. Rival Match Group (NASDAQ:MTCH) may be the more dominant force in the dating app industry. But, as analysts from Morningstar broke it down at the time of the IPO, this may be an overblown fear as well.
How does this relate to transitory inflation? If that scenario plays out, and interest rates stay low, richly-priced BMBL stock may avoid valuation contraction. Coupled with continually strong results, this “story stock” could have a path back toward its highs ($84.80 per share).
Endpoint cybersecurity provider Crowdstrike was a clear winner during last year’s work from home economy. But, just because offices are reopening, doesn’t mean high growth is off the menu. Analyst consensus calls for 55.7% revenue growth this fiscal year (ending January 2022), and 35.7% in the following fiscal year (ending January 2023). Earnings are set to increase 42.1%, and 83.8%, respectively, in FY2022 and FY2023.
“Significant runway” was the rationale behind Stifel’s recent upgrade of CRWD stock, from “hold” to “buy.” The sell-side firm also raised its price target, from $240 per share, to $300 per share (the stock trades for around $252 per share today).
With interest rates low, and its business growing so fast, investors have been willing to give shares a healthy premium. Crowdstrike today trades at a forward price-to-earnings (P/E) ratio of 668.7x, and a price-to-sales ratio of 52.5x. This leaves the stock at big risk of multiple contraction, if interest rates move back toward historic levels.
Trading near its highs, buying CRWD stock is a big bet that today’s inflation winds up being just a passing phase. But, if you’re confident in the transitory thesis? This could continue to remain a winner, as it continues to wow investors with its turbo-charged levels of growth.
Tech Stocks: Facebook (FB)
Social media powerhouse and “FAANG” component Facebook started off 2021 trading sideways. But, that changed as the year played out. Thanks to blowout quarterly results, driven by surging digital ad demand, shares have been on a tear. Since March, the stock has climbed from around $260 per share, to around $340 per share today. The question now is whether it can continue.
Much of it depends on where tech stocks overall are heading. If the worse-case scenario with regards to inflation plays out (Fed aggressively raises interest rates, valuations contract), not even reasonably-priced FB stock (forward P/E of 25.9x) could be immune.
But, if the thesis promoted by team transitory prevails? Not only could Facebook shares be able to hold onto their recent gains, but the stock could have room to benefit from multiple expansion as well. Why? Thanks to its aforementioned reasonable valuation, relative to its projected rate of growth.
It may trade at a valuation on par with other “FAANG” names, like Alphabet and Apple (NASDAQ:AAPL). But, given that other large tech behemoths like Microsoft (NASDAQ:MSFT), are able to command forward earnings multiples north of 30x, FB stock may have room to move up to this valuation. Combined with increased earnings, and its recent rally could carry on, with the stock continuing to make new highs.
Alphabet (GOOG, GOOGL)
Much like Facebook stock, shares in Google’s parent company have been rising, thanks to strong results from a booming ad market. Also, like its FAANG peer, the stock appears reasonably priced. Relative to both its growth prospects, as well as the quality of the underlying high-margin, cash-cow business.
And, again, like Facebook, despite these strengths, GOOG stock too is at risk of experiencing a big selloff, if future Fed actions do not line up with what team transitory inflation expects. But, if they’re correct, and tech stocks like this one don’t fall on valuation contractions?
Shares may be set to continue delivering solid gains in the coming years. As a commentator on Seeking Alpha recently made the case, there’s even a path for Alphabet to hit $5,000 per share by 2025. That’s nearly double its current trading price. Now, keep in mind that nearly doubling in four years may be a stretch goal for the stock. Especially given its already-gargantuan size ($1.67 trillion market capitalization).
But, if it succeeds in expanding beyond search and online video and into untapped areas like cloud storage and self-driving vehicles (as Dana Blakenhorn mentioned in his June 3 article on GOOG stock), assuming the Federal Reserve remains its current monetary policy stance, a continued run-up in its share price may be in the cards.
Tech Stocks: Nvidia (NVDA)
To those who believe the inflation situation will be more severe than anticipated (my view), NVDA stock looks like a better buy on the next tech stock pullback. Still running hot, any sort of threat to the story-stock valuation status quo could knock shares in the chip giant.
How low? Perhaps back down to under $600 per share. That’s where they traded as recently as late May (the stock trades for around $762 per share today). But, if this more cautious take doesn’t play out, and those betting on inflation being temporary are proven right? The buy-at-any-price mentality that’s made this one of the top performing large cap stocks will show no sign of slowing down.
Demand for both its CPU and GPU chips remains strong among a wide variety of end-users (data centers, gaming, even crypto mining). It’s not set in stone that these boom times are transitory as well. High levels of growth could carry on into the next fiscal year (ending January 2023).
Assuming high growth lasts longer than expected, and the company hits the top end of FY23 earnings projections ($22 per share), even if it’s forward multiple (44.4x) fails to expand, Nvidia may still have the ability to hit $1,000 per share.
Since last November’s U.S. presidential elections, it’s been somewhat of a roller coaster ride with Palantir stock. Shares zoomed after the election results came in, as investors bet big that the incoming Biden administration would be a boon for the big data company’s bread-and-butter governmental business.
Its rally continued into 2021, as the meme-stock trend emerged starting in late January. Yet, the dissipation of the first meme stock wave, coupled with the start of inflation/interest rate worries, led to big declines during the spring.
Since May, when the Reddit set returned to their favorite plays, and investors shrugged off the second round of inflation concerns, PLTR stock has bounced back, from under $20 per share, back to around $26 per share today. Sentiment about it is shifting back to positive. And, this could continue, if the Fed ends up maintaining its dovish (low-interest rate) stance.
If this happens, the rich forward multiple (173.9x next year’s earnings) could not only hold, but expand as well. This could send the stock back to $30 per share, $40 per share, or even back to its meme-stock highs of $45 per share. Bear in mind its high volatility, relative to the other tech stocks discussed here. But, if you’re looking for a stock with big upside potential, if the inflation Cassandras are proven wrong, this may be one such play.
Tech Stocks: Shopify (SHOP)
A few weeks back, I discussed how SHOP stock was one of many stocks overall (tech and non-tech) that could surge if inflation worries subside. Since publication, that’s started to happen. Shares in the e-commerce SaaS play continue to bounce back, following their pullback in the spring.
It’s up more than 23% over the past month, and just a few percentage points away from its all-time highs. Yet, Shopify could continue to defy its skeptics if interest rates stay as-is. Sure, even without the inflation/interest rate factor, valuation may still be a concern.
Take a look at its sky-high forward multiple (346.6x). Even to investors who aren’t rigid about valuation, this seems unsustainable. At the very least, after its nearly five-fold increase in value since the March 2020 coronavirus crash, shares may generate more modest return from here, as the company grows into its valuation.
But, there’s still a possibility SHOP stock hits new highs over the next year or two. As long as interest rates stay low, and the buy-at-any-price mentality I mentioned above with Nvidia stock still holds. Growth investors more conscious of valuation may prefer less richly priced plays that are still a bet against inflation bears. But, if you are bullish that the hottest tech stocks will remain hot, this is another play to consider.
On the date of publication, Thomas Niel did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Thomas Niel, a contributor for InvestorPlace.com, has been writing single-stock analysis for web-based publications since 2016.