The “growth vs. value” debate is the same as ever. But, after an exceptional 2020, the stakes are higher this year. Economic reopening, overheated valuations and rising bond yields all mean that the value camp is hearing a death knell for tech stocks. Trouble is, performance from the growth camp isn’t so “growthy” right now. Cathie Wood’s ARK Innovation ETF (NYSE:ARKK) — the poster child for disruptive tech investing — was down 12% year-to-date (YTD) as of the close of May 28.
However, technology growth investors don’t need to sit on the sidelines this year (or even become value investors). The alpha lies somewhere in between.
On one side of the divide are the “Big Tech” FAANG stocks – Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Netflix (NASDAQ:NFLX) and Alphabet (NASDAQ:GOOG, GOOGL). These stocks are (arguably) mature business models with limited upside this year. Facing difficult year-over-year (YOY) comparisons, rich valuations and the potential slowing of their core businesses, the FAANGs gained 12% YTD as of May 28. That’s essentially in line with the S&P 500, but down from a whopping return in 2020.
On the other side of the divide are early-stage tech growth stocks. These names were big winners in 2020, but they’ve underperformed this year. Wood’s investing style hasn’t changed, but the market has. In a rising-interest-rate environment, valuations deflate because investors stop chasing stocks that won’t deliver meaningful earnings for another decade or more.
But growth investors don’t need to choose between the extremes of value and growth. In fact, tech stocks at the intersection of the two have been the real winners so far this year.
This article will cover 11 large-cap tech stocks — “mature unicorns,” to use Bill Ackman’s phrase — which have outperformed the market, posting about 30% growth YTD. Unlike the FAANGs, there’s plenty of runway for revenue and earnings growth among the group. And, unlike many early-stage tech stocks which have yet to confirm their viability, these unicorns are proven winners. These stocks offer expanding revenue, profitability and businesses with value that won’t change materially in a rising-interest-rate environment.
With the market expected to trade sideways for now, investors who understand this distinction can capitalize on a huge trading opportunity this year. Here’s where to start.
Large-Cap Tech Is Alive and Outperforming the Market
Despite interest rate and sector rotation concerns, there are plenty of 2021 technology growth stories. The table below — which is based on the May 28 close — shows 11 large-cap tech stocks. Defined by a market capitalization of $20 billion or more, these companies are centered in tech’s fastest-growing product categories. These include semiconductors, computer hardware, Cloud and electric vehicles (EVs).
This group of large-cap names (with the exception of Tesla (NASDAQ:TSLA)) is outperforming the market, with a YTD average return of 31%. That’s well ahead of the S&P 500, which is at 14% over the same period. Meanwhile, the FAANG stocks are essentially in line with the market, generating a 12% return over the same period. And finally, Cathie Wood’s ARK Innovation ETF — the poster child for disruptive innovation — is in negative territory. ARKK stock is down 12% over the same span of time.
FAANGs: Mature Business Models Facing the Law of Large Numbers in 2021
It feels a bit jaded to call a tech stock that delivered a 70% return last year “dead money.” But the truth is, year-to-date, Apple has underperformed the market and its peers. AAPL stock was down 4% YTD as of May 28 and is down even further today. That’s despite the fact that the Technology Select Sector SPDR ETF (NYSEARCA:XLK), which Apple belongs to, is now up 6% YTD.
So, what’s wrong with the FAANGs? Nothing, really. But these stocks are all likely to underperform this year for a reason: after exceptional returns in 2020, comparisons this year are much harder to beat. Add even more questions to that already high bar — mounting concerns about privacy, monopoly, taxes and how much growth is left in these businesses — and you have a potentially bumpy ride.
The FAANGs’ long-term growth story is also up for debate. For Apple and Netflix, there are worries that they may be hitting a plateau. Additionally, Facebook and Google now dominate digital advertising. But, with U.S ad spending slowing, how much gas is left in the tank? And then there’s Amazon, the e-commerce giant whose expansion into groceries requires a huge investment in warehouses and equipment — potentially at the expense of a massive cloud opportunity.
Tech Investing in 2021: Looking for High-Quality Growth
With returns at the market’s extremes appearing stretched, it’s clear that investors need a new place to look. This year’s winners aren’t the biggest or the smallest. They’re the quality technology growth stories that exist in between.
So, what names should you be keeping an eye out for? Here’s what they look like:
- proven brands
- defensive moats (pricing power)
- expanding addressable markets
- high (expanding) operating margins
- high free cash flow (some exceptions)
We’ve noted 11 stocks that fit the bill in the table above, but here are some highlights.
Tesla and Microsoft, the Best of the Unicorns
Microsoft (NASDAQ:MSFT) and Tesla remain my favorite large-cap tech names for 2021.
For one, Microsoft is riding massive waves in Cloud computing and artificial intelligence (AI), both of which are now woven into the DNA of the company. Revenue from Xbox content and services surged over 30% last quarter. The company’s portfolio of remote-work offerings also has the potential to overtake Zoom (NASDAQ:ZM) and others in the enterprise market. It’s a “Big Tech” story firing on all cylinders.
Tesla, on the other hand, is the only stock in the group down YTD. With TSLA stock having gotten caught in the growth-value debate, the recent pullback is an excellent buying opportunity — particularly as the company enters the last bastion of the traditional auto market: SUVs.
This company’s share gains in the $5 trillion auto market should accelerate. Why? The reason is simple: most automakers are entrenched in a decades-old pattern. They focus just on lowering their powertrain costs slightly. Tesla, however, has a ground-up focus, creating vehicles which integrate developments in design, software, efficiency and cost. With growth projections indicating a 15% CAGR over the next five years, I continue to build positions on any weakness in TSLA stock.
Old-Fashioned Revival at HP
It’s easy to forget that HP (NYSE:HPQ) was the original Silicon Valley stock. The company provides personal computing, imaging and printing products. Last quarter, revenue rocketed 27% YOY to $15.9 billion — HP’s best growth since splitting with its parent company, Hewlett Packard Enterprise (NYSE:HPE), in 2015.
Designed for consumers and small businesses, the company’s HP+ printing business has also been benefitting from a post-pandemic “stay at home” workplace. HP even resisted the tech selloff. At an 8.53 forward price-earnings ratio and a 2.6% dividend yield, it can be considered a value stock, too. The company returns most of its free cash flow to investors via buybacks and dividends. These returns can fully offset any slowing in the top and bottom line.
The Global Chip Shortage Is Good News for AMAT and STX
Next, here are two examples of technology companies with pricing power.
While the global chip shortage is hurting Apple and other names, it’s a lift for companies like Applied Materials (NASDAQ:AMAT) and Seagate (NASDAQ:STX). Both AMAT stock and STX stock were up 59% YTD as of May 28.
Additionally, AMAT projects revenue and earnings per share (EPS) growth of over 55% and 100% by fiscal 2024. The company is also committed to returning between 80% and 100% of free cash flow to shareholders. Meanwhile, Seagate is a large-cap play on Cloud computing. The company is also a key beneficiary of rising demand for laptop data storage and the recent Chia (CCC:XCH-USD) crypto craze.
Cloud Creates an IT Services Revival for Gartner
Lastly, though, there is no better earnings story than what’s happening at Gartner (NYSE:IT). This company is benefitting from an IT spending shift toward Cloud.
In Q1 2021, Gartner reported its third-straight quarter of earnings acceleration and its first revenue gain since Q1 2020. The company expanded EPS by an average of about 45% over the past three years — despite a 3.4% decline in revenues last year. At 22 times forward EBITDA, IT stock trades at a discount to earnings growth.
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On the date of publication, Joanna Makris 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.
Joanna Makris is a Market Analyst at InvestorPlace.com. A strategic thinker and fundamental public equity investor, Joanna leverages over 20 years of experience on Wall Street covering various segments of the Technology, Media, and Telecom sectors at several global investment banks, including Mizuho Securities and Canaccord Genuity.