How crazy are technology ratings?

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Dear Fool,

so far it has been the year of technology stocks. While most of the leading indices are still below old highs, technology stocks are rushing from record to record. The technology-heavy American NASDAQ 100 index was almost a tenth higher than it was before the pre-Coronavirus crisis earlier this week, and has gained a third in the past twelve months.

This raises the question of how expensive technology stocks have become. Many already draw a comparison to the Internet bubble at the turn of the millennium. Let’s take a look at a few numbers by comparing total enterprise value (an alternative to market capitalization) with sales. The advantage compared to sales is that you look at the most basic element of a company that cannot really be influenced by special effects.

TEV sales ratio
Alphabet 5,7
Amazon 5,2
Apple 6,2
Microsoft 10,4
Shopify 66,6
Zoom 84,6

As of July 27, 2020, TEV = Total Enterprise Value, a company’s TEV is its market capitalization plus interest-bearing debt and preferred shares, but minus its cash, source: S&P Capital IQ

The big technology companies Alphabet, Amazon, Apple and Microsoft are optically relatively expensive, but not necessarily very expensive. For Alphabet, Apple and Microsoft, the valuation surcharges are understandable primarily because all companies regularly achieve net margins of over 20%, leaving a large amount of sales as a profit. Microsoft has even had margins of over 30% recently, which can be explained in mathematical terms pretty much the additional premium compared to Alphabet and Apple.

Amazon, on the other hand, has much lower margins (just over 4% in the 2018 and 2019 financial years), but also because the company is investing heavily in future initiatives. So it can continue to achieve strong sales growth.

All in all, it can be imagined relatively well for all four companies how – building on their strong market positions – they justify their current valuations with a mixture of growth and good margins and thus continue to deliver good returns. However, it could still be the case that technology stocks are now rather expensive compared to other stocks. So let’s take a look at the ratings of four classics from the American corporate landscape.

TEV sales ratio
Coca Cola 7,1
Johnson & Johnson 5,0
Procter & Gamble 4,8
Visa 18,0

Stand: 27. Juli 2020, Quelle: S&P Capital IQ

As you can see, these companies are not really cheaper. Visa is even significantly more expensive, but it also has incredible net margins of 50% and more, so its sales are very valuable and it is valued like a dynamic technology company, which it is in some ways. That Coca Cola, Johnson & Johnson and Procter & Gamble Long-term enough growth and margin strength to justify their valuations, which are similar to those of the large technology companies, is not a sure-fire success.

With a view to the large companies, one cannot speak of a technology bubble. For the somewhat smaller companies, this is more complicated. Companies like Shopify and Zoom are strongly rewarded for being leaders in important niches and growing rapidly.

How fast they continue to grow and what their margin profile will look like in a few years will determine whether today’s valuations are overstated. They may turn out to be exaggerated, but there is also a possibility that they may grow into their ratings. You have to be aware of how strong the compound interest effect can be. If Shopify and Zoom increased their sales by 50% a year for half a decade – which is demanding but conceivable – sales would almost increase eightfold. If the courses remained the same, their evaluation would be similar to that of Microsoft today.

Technology stocks have been the big winners of this year so far. One or two price jumps will prove to be unsustainable, but a technology bubble that is sweeping the entire market cannot be identified from the current valuations.

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The post How crazy are technology ratings? appeared first on The Motley Fool Germany.

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Disclosure: Marlon Bonazzi owns shares in Amazon and Shopify. John Mackey, CEO of Amazon subsidiary Whole Foods Market, sits on The Motley Fool’s board of directors. Suzanne Frey is a senior executive at Alphabet and sits on The Motley Fool’s Board of Directors. Teresa Kersten works for LinkedIn and sits on The Motley Fool’s Board of Directors. LinkedIn is part of Microsoft. Randi Zuckerberg, a former head of market development and spokeswoman for Facebook and sister of CEO Mark Zuckerberg, sits on The Motley Fool’s board of directors. The Motley Fool owns shares of and recommends Alphabet (A and C shares), Amazon, Apple, Microsoft, Shopify, Visa and Zoom Video Communications. The Motley Fool recommends Johnson & Johnson. The Motley Fool recommends the following options: Long January 2021 $ 85 calls on Microsoft, Short January 2021 $ 115 calls on Microsoft, Short January 2022 $ 1940 calls on Amazon, Long January 2022 $ 1920 calls on Amazon and Short August 2020 $ 130 calls on Zoom Video Communications.

Motley Fool Deutschland 2020

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