Tech stocks: Don’t run with the crowd

Dramatic swings in the tech sector in recent months have fostered a herd mentality that investors would do well to avoid.

Earlier this month we noted the NASDAQ index, which is dominated by high flying growth stocks across the technology and biotech sectors, had succumbed to heavy profit taking, fuelled by stretched valuations and fund positioning.

The volatility even spread to our shores, with a number of online and technology stocks falling victim to profit taking. Some of the larger names included REA Group (REA), Seek (SEK) and (CRZ).

It was then interesting to see that technology stocks globally rebounded for almost a fortnight until another bout of selling at the end of last week.

Having fallen close to 10 per cent from its highs of early March to the lows of mid-April, the NASDAQ rebounded by as much as 5.9 per cent, while the S&P/ASX 300 Information Technology index experienced similar movements having dropped 9.4 per cent in one month before rebounding 6.0 per cent.

What caused the sell-off was primarily a fear that the technology stocks that had posted the biggest gains during the five-year bull market were overvalued and particularly vulnerable ahead of the earnings season. Little attention was being paid to the fundamentals of each business.

While there is no denying that many companies were, and still are, trading at extremely high multiples, this does not necessarily mean an entire sector should be sold off globally.

Late last week, both Apple and Facebook provided the tech sector with a much needed confidence boost when they released quarterly earnings results that beat analyst expectations. While this was not exactly a slap in the face for all of the bears out there that have been calling for the second tech bubble in the last decade-and-a-half, it is certainly a positive. 

As the aforementioned index movements suggest, there has been a correlation in the movements of both the US and Australian technology sectors in recent months, much of which can be attributed to the large amount of noise that has surrounded the IT space during this period.

What this noise has created is a ‘herd mentality’, where some stocks are being sold off for no reason other than for the fact they operate in a particular sector. There has been little consideration for the fact the sector is extremely diverse and constantly evolving.

Since the original sell-off we have seen a number of stocks bounce as the valuations had become more attractive for investors. Naturally it was some of the larger caps that led the way including Carsales, REA and Seek which all rallied over 8 per cent from their lows of a couple of weeks earlier.

At more than 30 times earnings, one argument against investing in some of these stocks has been that they are too expensive, with the concern being that one false step and they will tumble. This is too simplistic a view because some companies deserve such valuations. Such companies are likely to benefit most when the market turns bullish. 

While the technology sector is in a position to benefit when momentum returns to the market, it is still important to consider high-quality stocks rather than having an ‘any stock will do’ attitude. 

Ben Larsen is a retail research associate at Baillieu Holst Ltd.

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