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Tech stocks: Cape fears suggest sell off has further to go

It is fitting that shares in online broker Robinhood are down 80 per cent from their high. Live by meme stock mania, die by meme stock mania. But the great tech stock rout is proving uneven. Cryptocurrency platform Coinbase is off 45 per cent, following the trajectory of bitcoin’s decline. Meanwhile, giants such as Alphabet have lost about a tenth of their market value.

Rising interest rate forecasts triggered the sell off. After taking the US market to a record, the tech sector is now dragging it down. The S&P 500 has fallen 8 per cent from its high point at the start of the year. Reversion to the mean would require an even bigger drop. The index still trades at 20 times expected earnings. The historical average is under 15 times.

Look at the cyclically adjusted price-earnings multiple — aka the Shiller Cape index — and it is clear how expensive stocks are. The index, made popular by Yale economist Robert Shiller, compares prices to inflation-adjusted earnings over the past decade in an attempt to smooth out earnings fluctuations. It remains way above the average at 36 times.

However, if a valuation reset is under way the tech sector should not be regarded as homogenous.

It makes sense that streaming assets are being downgraded, for example. Netflix shares are down nearly a quarter after announcing poor subscriber growth figures last week. That is because the stock trades on debt-funded growth. Peloton has also burnt through cash in order to grow. Falling user engagement warrants a mark down.

Tech giants with rising free cash flows and large net cash positions are a safer bet. Alphabet has $142bn to hand, for example. Its ebit margin is forecast to stay close to 30 per cent over the next couple of years.

Growth forecasts will compare poorly to those issued in the midst of the pandemic-driven boom in digital spending. But the trends driving that growth have not disappeared. Global IT spending is forecast to rise more than 5 per cent to $4.5tn this year, according to Gartner. Inflated valuations may be evaporating but the sector’s utility has not.

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