For anyone watching the stock market for a living, the recent car crash in tech stocks has been fascinating. There are plenty of reasons to believe that it is not over.
That’s not so much of a problem for Big Tech, although the wealth wiped out since the start of the year is significant. Between them, the five largest tech companies lost nearly $2.6 billion. This is a decline of 26%, double the decline of the Dow Jones Industrial Average.
There are still serious questions. Amazon is undergoing an unusually harsh adjustment after a massive spending spree, while the problems facing Meta as the former Facebook tries to reposition itself as a metaverse company are pretty much existential. But in general, Big Tech’s premium to the rest of the market has largely been erased, and the defensive qualities of the companies should show up in tougher economic times.
The ax instead hangs on high-growth tech companies. This is where valuations have become most stretched and where the market is struggling the most to find its nadir. As investors scramble to find more appropriate financial yardsticks to judge these companies, and the right valuation multiples to apply to those metrics, volatility is expected to remain high.
Earnings multiples were a favorite that growth investors used to chase stocks higher, at least until the turning point that happened last November. On this measure, there is ample room for further declines, especially since markets often overshoot on the downside as well as on the upside.
Zoom is now trading at less than six times this year’s expected sales, a far cry from the 85-plus revenue multiple it peaked in 2020. But Redpoint Ventures’ Tomasz Tunguz calculated this week that even after falling nearly by 70%. , cloud software companies are still trading at a 50% premium to the price/revenue multiples they were at in 2017.
Earnings multipliers are also fast falling out of favor as investors try to assess the sustainability of companies that were built for growth but are facing a financial shock and potential economic downturn. Investors and tech executives are beginning to shift away from two favorite profit measures that have imposed themselves on tech investors as the market boomed: earnings before interest, taxes, depreciation and amortization; and net income which excludes stock compensation costs.
Dara Khosrowshahi, chief executive of Uber, told staff at the ridesharing company this week that, in a tougher financial climate, it was time to ditch the company’s Ebitda targets and become a flow. positive cash flow. After burning nearly $18 billion since 2016, it’s lucky for him that Uber is already close to hitting that milestone – although it will take a renewed focus on cost to become sustainably profitable on This measure. Many other technology companies, accustomed to cash supply in good times, are still far from reaching the free cash flow milestone.
Distributing restricted stock to employees, meanwhile, has become a cashless way for many companies to find talent in a hot tech job market without hurting the earnings measures that Wall Street has lent most credit to. Warning. Workers have come to view equity compensation as a guaranteed supplement to their regular income, rather than the lottery of options it once was. As Third Point’s Dan Loeb wrote to his investors this week, this will force companies to either raise cash wages to satisfy workers, or issue far more stock, which will dilute existing shareholders but would not not obvious to anyone still considering non-GAAP earnings measures.
Meanwhile, there are many other companies that make no profit on any metric and very few sales, making it all the more difficult for the market to find a bottom.
Electric truck maker Rivian reached a market value of $91 billion when it went public last year, despite selling only a handful of vehicles. After plunging 80%, Rivian may have found some sort of bottom: On Wednesday, it was trading almost exactly at book value, thanks to the $15 billion in net cash on its balance sheet. That proved to be a good base for a 14% rebound on Thursday after the company reported earnings.
Many companies in a similar situation don’t have that kind of balance sheet to fall back on. This is especially true of Spacs, or special purpose financing vehicles, which have been used to take early-stage companies public. As the flight from risk continues, even today’s stressed valuations may seem overly optimistic.
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