Are tech stocks overvalued? Depends on who you ask — and what metric you use.
On one hand, the price-to-earnings ratio (P/E), the most traditional measure of valuation, remains low relative to both history for the tech sector and the broader S&P 500.
On the other, the ratio of tech enterprise value to sales is the highest since the dotcom bubble when compared to the benchmark. Not to mention that the tech trade is more crowded with large fund managers than at any point since the start of the eight-year bull market.
This has Bank of America Merrill Lynch at an impasse when it comes to the stock market’s hottest industry.
“Valuation signals are mixed and investor positioning is a significant source of near-term risk, but still attractive fundamentals and quant scores provide the offset,” a group of equity strategists at the firm led by Savita Subramanian wrote in a client note. “We remain marketweight the tech sector.”
Canaccord Genuity strategist Tony Dwyer isn’t so much worried about the valuation of the tech sector as he is about the number of stocks hitting new 52-week highs.
The measure, known as breadth, sits at 44% for the S&P 500 Technology Index, a rate only seen twice before (June 1995 and July 1997). And on both of those occasions tech stocks climbed higher for a few weeks before dropping 20% over roughly the next 100 days, Dwyer wrote in a client note on Wednesday.
Meanwhile, some investors are worried that tech sector gains have been driven by a small number of stocks — a development that they think could cause a meltdown, especially since the trade is so crowded with institutional investors.
Goldman Sachs says these fears are overblown. Crowding alone doesn’t pose a risk, and earnings growth has been strong enough to fend off any sort of meltdown, a group of equity strategists led by David Kostin wrote in a note to clients last month. The firm recommends an overweight rating for the sector, as well as a 23% portfolio weighting, the highest out of any S&P 500 group.
With all of that considered, if you’re still in the camp that maintains tech stocks are overvalued, the BAML derivatives team has a recommendation: make bets on price swings. They argue that fluctuations become more pronounced when an asset bubble is forming, so pessimistic investors would be best-served to go long volatility.
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