This is a little excerpt from Mitch Zack’s free email letter that I receive from time to time in my email. I thought you’d find it interesting. Mitch is the primary portfolio manager at Zacks Investment Management and oversees all investment management activities at the firm.
Technology stocks trade at more than a 10% premium to the broader market, which is significantly higher than the post-crisis 4% average.
But in my view, a closer look shows that maybe technology stocks should be trading at a higher premium, given that companies in the tech space are more profitable than the S&P 500 average. The current return-on-equity (ROE) for tech names is over 30%, which is nearly double the average ROE for S&P 500 companies. If you look at technology companies through a lens of price-to-cash flow versus the traditional price-to-earnings, the premium starts to make more sense.
Because technology stocks are in high demand and trading at a premium, they also tend to get beat up badly during market pullbacks… But that’s also precisely why market pullbacks can boost the case for long-term ownership of quality tech stocks.
As I write, the S&P 500 is up approximately +20% for 2019, but technology stocks … are up nearly +30%. In short: Getting beaten up on the way down can often give long-term investors attractive entry points. If you believe that there is a strong case for secular growth in the technology sector – which I do – then it follows that high-quality technology companies with competitive advantages have an opportunity to potentially deliver strong earnings growth for several years to come. Market pullbacks just make them temporarily cheaper.
He must have been reading our minds!