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The tech sector is up more than 18% this year, more than double the S&P 500’s roughly 7%.
But this is a huge sector, with many different kinds of companies offering very different kinds of products and services to often different markets. Therefore, it’s difficult to come up with common factors that drive the sector.
Until you look at the market capitalization of some of these companies. Alphabet (GOOGL - Free Report) for instance with its market cap of over $1.3 trillion has a much greater impact on the sector’s performance when it rises around 19% year to date than say BigBear.ai Holdings (BBAI), although this stock has soared 285%+. The same can be said of Microsoft (MSFT - Free Report) with its market cap of over $2.2 trillion (up nearly 27% year to date), or of Meta Platforms (META - Free Report) with its $614 billion market cap (up 94%) or Shopify (SHOP - Free Report) with its $59 billion (up 65%).
The point is that this is a sector with some very large cap stocks that skew the average whenever they make big moves. Since they have been making big moves this year, it makes sense to see why.
The biggest reason perhaps is the stabilization in the interest rate. As inflation rates continued to moderate, the markets have been expecting the Fed to stop raising rates. After the latest hike, the Fed has indicated that there may not be further hikes this year. Rate hikes are a problem for most growth stocks because these are the riskiest assets. Investors put their money into these stocks in the hopes that they’ll get outsized returns at some future date.
Technology companies may be younger or mature, but by their very nature, they invest huge capital in futuristic innovations that may or may not generate the anticipated returns. Therefore, when higher rates make less risky assets more attractive, some investors switch to those. Additionally, tech companies may also take a certain amount of debt to fund their R&D. Stabilization in the interest rate therefore makes these stocks more attractive.
Another reason for the big moves is the effect of the pandemic. In the initial phase of the pandemic, the rapid digitization generated huge business for some of these players. This pulled in five years of demand (by some estimates). As a result, demand dropped drastically in the following period, a situation that persists today, in some segments. Given the disappointing outlook, tech stocks plunged last year, making them more attractive from a valuation perspective.
The third reason, and this is specific to the larger cap tech stocks, is that although they invest humongous amounts of cash in their future innovations, they also have certain existing products that are pretty much like cash cows, generating year upon year of solid revenue and cash flows, as in the case of any good quality mature company.
Unlike mature players in certain other sectors, these stocks don’t pay dividends. Or, just a handful of them – like Apple – do. They tend to pour the whole thing back into the business and maintain large cash balances for financial flexibility. This makes them attractive in times of uncertain demand, especially the mild recession/soft landing that most analysts are anticipating.
So, let’s take a closer look at some of these big tech stocks:
Search giant Alphabet posted strong numbers last quarter, exceeding revenue estimates by 1.5% and earnings estimates by 10.4%. In the past month, the company’s 2023 earnings estimate increased 3.9% while the 2024 estimate increased 2.0%. Revenue and earnings are expected to increase an estimated 6.1% and 18.2% this year and 10.6% and 16.1%, respectively in the next.
A provider of computer software, productivity solutions, search, cloud infrastructure services and more, Microsoft is easily one of the most attractive players right now. In the last quarter, Microsoft’s earnings surprise of 10.4% came on top of a revenue surprise of 3.8%. Analyst estimates for the years ending June 2023 and 2024 have increased 2.9% and 2.4%, respectively. Its revenue is expected to increase 6.3% this year and 10.3% in the next. Earnings are expected to increase 4.3% and 12.1%, respectively.
Social media provider Meta posted a sales surprise of 4.2% in the last quarter, which resulted in an earnings surprise of 34.7%. In the last 30 days, its 2023 earnings estimate has increased 12.6% and 2024 estimate 13.2%. Analysts currently expect revenue growth of 8.6% this year and 10.8% in 2024. Earnings are expected to grow 19.6% and 24.3%, respectively.
Shopify provides an online commerce platform for small and medium-sized businesses (SMBs). The company’s March quarter earnings surprise of 50% came on top of revenues that surprised by 4.9%. Analysts have merely fine-tuned their estimates on this company’s revenue and earnings, which are expected to grow 18.1% and 25%, respectively in 2023 and 21.6% and 395.8%, respectively the following year.
Zacks #1 (Strong Buy) rating on Meta shares and a #2 (Buy) rating on the others.
Year-to-Date Price Performance
Image Source: Zacks Investment Research
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Why Are Tech Stocks Doing So Well This Year?
The tech sector is up more than 18% this year, more than double the S&P 500’s roughly 7%.
But this is a huge sector, with many different kinds of companies offering very different kinds of products and services to often different markets. Therefore, it’s difficult to come up with common factors that drive the sector.
Until you look at the market capitalization of some of these companies. Alphabet (GOOGL - Free Report) for instance with its market cap of over $1.3 trillion has a much greater impact on the sector’s performance when it rises around 19% year to date than say BigBear.ai Holdings (BBAI), although this stock has soared 285%+. The same can be said of Microsoft (MSFT - Free Report) with its market cap of over $2.2 trillion (up nearly 27% year to date), or of Meta Platforms (META - Free Report) with its $614 billion market cap (up 94%) or Shopify (SHOP - Free Report) with its $59 billion (up 65%).
The point is that this is a sector with some very large cap stocks that skew the average whenever they make big moves. Since they have been making big moves this year, it makes sense to see why.
The biggest reason perhaps is the stabilization in the interest rate. As inflation rates continued to moderate, the markets have been expecting the Fed to stop raising rates. After the latest hike, the Fed has indicated that there may not be further hikes this year. Rate hikes are a problem for most growth stocks because these are the riskiest assets. Investors put their money into these stocks in the hopes that they’ll get outsized returns at some future date.
Technology companies may be younger or mature, but by their very nature, they invest huge capital in futuristic innovations that may or may not generate the anticipated returns. Therefore, when higher rates make less risky assets more attractive, some investors switch to those. Additionally, tech companies may also take a certain amount of debt to fund their R&D. Stabilization in the interest rate therefore makes these stocks more attractive.
Another reason for the big moves is the effect of the pandemic. In the initial phase of the pandemic, the rapid digitization generated huge business for some of these players. This pulled in five years of demand (by some estimates). As a result, demand dropped drastically in the following period, a situation that persists today, in some segments. Given the disappointing outlook, tech stocks plunged last year, making them more attractive from a valuation perspective.
The third reason, and this is specific to the larger cap tech stocks, is that although they invest humongous amounts of cash in their future innovations, they also have certain existing products that are pretty much like cash cows, generating year upon year of solid revenue and cash flows, as in the case of any good quality mature company.
Unlike mature players in certain other sectors, these stocks don’t pay dividends. Or, just a handful of them – like Apple – do. They tend to pour the whole thing back into the business and maintain large cash balances for financial flexibility. This makes them attractive in times of uncertain demand, especially the mild recession/soft landing that most analysts are anticipating.
So, let’s take a closer look at some of these big tech stocks:
Alphabet Inc. (GOOGL - Free Report)
Search giant Alphabet posted strong numbers last quarter, exceeding revenue estimates by 1.5% and earnings estimates by 10.4%. In the past month, the company’s 2023 earnings estimate increased 3.9% while the 2024 estimate increased 2.0%. Revenue and earnings are expected to increase an estimated 6.1% and 18.2% this year and 10.6% and 16.1%, respectively in the next.
Microsoft Corp. (MSFT - Free Report)
A provider of computer software, productivity solutions, search, cloud infrastructure services and more, Microsoft is easily one of the most attractive players right now. In the last quarter, Microsoft’s earnings surprise of 10.4% came on top of a revenue surprise of 3.8%. Analyst estimates for the years ending June 2023 and 2024 have increased 2.9% and 2.4%, respectively. Its revenue is expected to increase 6.3% this year and 10.3% in the next. Earnings are expected to increase 4.3% and 12.1%, respectively.
Meta Platforms, Inc. (META - Free Report)
Social media provider Meta posted a sales surprise of 4.2% in the last quarter, which resulted in an earnings surprise of 34.7%. In the last 30 days, its 2023 earnings estimate has increased 12.6% and 2024 estimate 13.2%. Analysts currently expect revenue growth of 8.6% this year and 10.8% in 2024. Earnings are expected to grow 19.6% and 24.3%, respectively.
Shopify Inc. (SHOP - Free Report)
Shopify provides an online commerce platform for small and medium-sized businesses (SMBs). The company’s March quarter earnings surprise of 50% came on top of revenues that surprised by 4.9%. Analysts have merely fine-tuned their estimates on this company’s revenue and earnings, which are expected to grow 18.1% and 25%, respectively in 2023 and 21.6% and 395.8%, respectively the following year.
Zacks #1 (Strong Buy) rating on Meta shares and a #2 (Buy) rating on the others.
Year-to-Date Price Performance
Image Source: Zacks Investment Research