Quick takes on capital markets

14 Jan 2022

Tech stocks: Challenged, but not all created equal

Although rising bond yields are challenging the entire tech sector, investors must distinguish between profitless names that are a long way from demonstrating healthy earning power and mega-cap tech firms that can defend their margins.

Technology stock performance
Total return, indexed to 100 at January 2017

Technology stock performance chart
Source: Clearnomics, Standard & Poor's, Refinitiv, Principal Global Investors. FAANG consists of Facebook, Apple, Amazon, Netflix, and Alphabet (Google). Data as of January 7, 2022.

During the recent spike in bond yields, technology stocks were collateral damage, underperforming the broad market. With rates biased higher over the coming months, investors should be prepared for parts of the tech sector to again be challenged.

Given tech's stellar run (+252% since 2017, compared to 105% for the S&P 500 index), investors may be waiting for the other shoe to drop. As financial conditions tighten and pandemic headwinds ease, cyclical conditions become increasingly unfavorable for the sector. But not all tech is created equal. Certainly, in this environment, profitless firms, such as those represented by the Goldman Sachs Non-Profitable Tech Index, will struggle as profit margins are stressed further. Additionally, these unprofitable companies are particularly vulnerable to rising rates, as they derive almost all their present value from future cash flows.

By contrast, mega-cap tech firms, such as the FAANGs, who already generate huge cash flows, exhibit strong pricing power, and offer impressive earnings delivery, should be significantly more resilient.1

Investors have been rewarded by the "overweight tech" trade for the better part of the past decade. And while conditions for the sector are becoming trickier, strong companies with robust balance sheets and pricing power still have further to run. For the profitless ones, tech-nically speaking, the period ahead may not be so pretty.

1FAANG consists of Facebook, Apple, Amazon, Netflix, and Alphabet (Google)

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Disclosure

Goldman Sachs Non-Profitable Technology Index consists of non-profitable U.S. listed companies in innovative industries. Tech is defined quite broadly to include new economy companies across GICS industry groupings. The basket is optimized for liquidity with no name initially weighted greater than 4.65%.

Wall Street Journal Custom Content is a unit of The Wall Street Journal advertising department. The Wall Street Journal news organization was not involved in the creation of this content.

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