32 BARRON’S March1,2021
TECH TRADER
Some of the inflationary pressure is coming from
tech itself, with rising demand for 5G phones,
PCs, cloud servers, and compute-heavy cars.
Rising Rates Are
Killing Tech Stocks—
How to Avoid the Pain
Despite the rally, HP shares are still
trading at under 10 times fiscal 2022
non-GAAP profits.
Mortonson is focused on companies
with dominant positions and scale,
along with balance sheets to invest in
R&D. As bets on digital transforma-
tion, he suggestsAccenture(ACN),
the leading IT consulting and integra-
tion firm, andTwilio(TWLO), which
provides a suite of communications
tools to many websites.
Paul Meeks, portfolio manager of
the Wireless Fund, likes semiconduc-
tor stocks, with chip supplies short
even before the economic recovery has
set in. He told me that memory-chip
makerMicron Technology(MU)—
featured in this column late last year—
“still may be my best idea.”
The big opportunity might be in
old-school technology—not just HP,
but also Dell,Hewlett Packard En-
terprise(HPE),IBM(IBM),Cisco
Systems(CSCO),Oracle(ORCL), and
Seagate Technology(STX)—as infor-
mation-technology spending picks up
later in the year.
Of that group, all of the stocks trade
below five times sales and 15 times
earnings. The real irony is that these
stocks, ignored in the 2020 FOMO
rally, benefit from the same cloud
trends that have driven the likes of
Snowflake and C3.ai. The cloud isn’t
water vapor—it’s filled with servers,
disk drives, routers, and switches.
And the companies that make that
stuff are a whole lot cheaper than the
cloud stocks themselves.B
By Eric J. Savitz
Courtesy of HPI
n 2020, tech stock valuations
were driven by FOMO—fear
of missing out. Aggressive
investors ignored signs of
valuation excess, bidding up
stocks with high revenue
growth—like Zoom, Snow-
flake, DoorDash, and Airbnb. The
GAAP strategy—growth at any price
—resulted in expensive stocks, but
FOMO kept them rallying.
But that was then. Ted Mortonson,
technology strategist at investment
bank Baird, thinks the new tech dy-
namic is FOGK—fear of getting killed.
Let’s take a look at what’s happened
and where investors can turn for shel-
ter from the storm.
The sudden, broad stumble in tech
stocks—the Nasdaq Composite is
down 7% over the past two weeks—
was ignited by rising interest rates.
The yield on 10-year Treasury notes
has jumped to 1.54%, from 0.93% at
the beginning of the year. And the
higher rates go, the more pressure
there is on high-priced tech.
David Readerman, who runs Endur-
ance Capital Partners, a San Francisco–
based tech hedge fund, notes that the
discounted terminal valuation of high-
growth stocks gets marked down
sharply in a rising-rate environ-
ment. That’s because the higher
rates go, the less future profits are
worth in today’s dollars.
Most at risk, he says, are com-
panies with minimal cash flow and
valuations tied to their perceived ter-
minal value. That description fits much
of the 2020 initial-public-offering
class, particularly stocks likeC3.ai
(ticker: AI) andSnowflake(SNOW).
As a result, investors are dumping
pricey tech stocks and moving into
economically sensitive—and rate-sen-
sitive—sectors like energy, financial
services, industrial materials, and
healthcare. Is the damage done?
“Based on my 30 years of experience,”
Mortonson wrote, “the answer is no.”
He added that Wall Street earnings
models might not yet account for in-
creased operating costs in the quarters
ahead, including higher financing
costs, increased component pricing,
and the return of travel and entertain-
ment budgets, among other factors.
Dell Technologies(DELL) CFO
Tom Sweet warned investors last
week that 2021 operating margins
would drop from 2020 levels, in part
due to the restoration of employee
benefits withdrawn at the darkest
months of the pandemic last spring.
(Dell stock still rallied on its strong
overall fourth-quarter results.)
“There is no real fear yet,” Morton-
son said. “Investor panic must be felt
to get to a real bottom.”
R
eaderman suggests that tech
investors hide in “deep
value.”HepointstoHP Inc.
(HPQ), which last week
posted fourth-quarter sales and prof-
its that crushed Wall Street estimates.
The PC and printer company bought
back close to 5% of its market value in
the most recent quarter alone, and it
plans to keep right on buying—at least
$1 billion a quarter. HP shares have
more than doubled since last March.
Last week, we listed 15 tech stocks
trading for at least 35 times forward
sales, including Snowflake and C3.ai.
As of late Thursday, all 15 were down
on the week, by an average of 12.6%.
The trouble isn’t simply higher
rates. It’s how quickly they’ve spiked,
according to Mortonson. Indications
of inflation have pushed rates up
faster than anyone anticipated.
“Higher input costs are evident
across the board,” he wrote in an email.
Some of those costs stem from the
tech industry itself, with rising de-
mand for 5G handsets, PCs, cloud-
based servers, and compute-heavy
cars triggering widespread chip short-
ages. Auto makers have cut production
for lack of parts, and PC makers don’t
have enough chips to meet demand.
Mortonson thinks the prospect of a
new $1.9 trillion stimulus package—
now winding its way through Con-
gress—strikes some investors as “add-
ing lighter fluid to a raging bonfire.”
The 2020 rally in high-priced
tech stocks has been upended
byaspikeininterestrates.
Now the opportunity could be
in old-school technology—stocks
like HP Inc. and HP Enterprise,
along with Cisco, Dell, and Seagate.