Virus brings rare entry for tech stocks

Wild weeks on Wall Street have opened some tempting opportunities

Vikram Barhat 18 March, 2020 | 1:13AM
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The stock market carnage in February, that saw the Dow plunge more than 3000 points, continues to fuel uncertainty in March. The ongoing sell-off triggered by fears over the spread of the deadly coronavirus has clobbered stocks across sectors and geographies.

As fears and uncertainty roil equity markets, companies in the U.S. tech sector with substantial revenue exposure to China have been hit the hardest. The Morningstar U.S. Technology Index has fallen 2.5% for the year to date (expressed in U.S. dollars) while the S&P Technology Select Sector Index gave up 2.2% for the same period, as of Mar 03.

Given the daily dose of spooky headlines, there couldn’t be a better time to remind investors of Warren Buffett’s famous words about the stock market investing: “Be fearful when others are greedy and greedy when others are fearful.”

Opportunistic dip-buying investors are pouncing on discounted blue-chip tech stocks that have suddenly become cheap from the market meltdown. A closer review of these companies would reveal their underlying fundamentals remain unchanged and their long-term prospects continue to be strong, driven by secular growth trends.

The virus-driven volatility has opened attractive entry points for the following tech heavyweights that have suffered double-digit losses from their all-time highs. Now may be a good time, therefore, to capitalize on the rare price disconnect between the fair value and market value of these quality names.

 

Apple Inc.  
Ticker: AAPL
Current yield: 1.11%
Forward P/E:   21.28
Price:  US $256.82
Fair value:  US $240
Value:  Fairly valued
Moat:  Narrow
Moat trend:  Stable
Star rating:  **
Data as of Mar 16, 2020  

The iPhone maker and the world’s second most valuable company, Apple (AAPL), makes a range of premium digital devices including handsets, iPads, Apple TV, iPods, iMacs, Apple Watch. The company has been generating a growing portion of its revenue from multiple services ranging from iCloud, Apple Pay, Apple Music, Apple TV+ and AppleCare, among others.

In the wake of the virus outbreak, Apple recently announced it no longer expected to meet its Jan 28 revenue guidance due to supply disruption and weaker demand in China. However, it is likely that any near-term shortfall will be made up in subsequent quarters with the u the 5G iPhone 12 launch in September, says a Morningstar equity report.

“We view the iPhone as a revolutionary product that created the smartphone ecosystem and transitioned computing habits away from the PC,” the report says, adding that “the robust app store helped foster iPhone adoption and grow Apple’s user base.”

In a bid to lower its reliance on the iPhone revenue, Apple has been increasing its focus on newer software and services. “The firm’s additional products and services (Apple Watch, iCloud, Apple TV+, AirPods, Apple Pay) act as both supplemental revenue opportunities and, more importantly, critical enhancements to the iOS ecosystem that support Apple’s crown jewel: the iPhone,” says Morningstar equity analyst, Abhinav Davuluri, who recently upped the stock’s fair value from US$220 to US$240, projecting iPhone revenue to grow 13%, boosted by the upcoming 5G iPhone model.

Davuluri forecasts services to cross the US$50 billion mark in 2020, driven by “broad-based strength, while wearables [segment] also maintains strong double-digit growth.”

 

Microsoft Corp  
Ticker: MSFT
Current yield: 1.28%
Forward P/E:   25.38
Price:  US $144.07
Fair value:  US $185
Value:  22% Discount
Moat:  Wide
Moat trend:  Stable
Star rating:  ****
Data as of March 16, 2020  

Tech titan and the world’s most valuable company, Microsoft (MSFT) develops and licenses consumer and enterprise software. The firm, known worldwide for its Windows operating systems, operates three business segments: productivity and business processes; intelligence cloud; and personal computing.

Microsoft stock fell nearly 13% in the last two weeks of February and was trading as of March 16 at US$144, far below its US$190 high in the second week of Feb. However, the company’s prospects remain stellar under the leadership of Satya Nadella, who reinvented Microsoft into a cloud leader.

“Adoption of IaaS, PaaS, and SaaS cloud services remains robust and continues to outperform our expectations from both a revenue and margin perspective,” says a Morningstar equity report, referring to the firm’s latest earnings report.

The company has had a string of impressive quarterly earnings, with meaningful upside to revenue, operating margin, and profit. “Microsoft is firing on all cylinders and [we expect to] see further upside to shares if the company can continue to deliver results like those reported for the second quarter,” says Morningstar analyst, Dan Romanoff, who recently raised the stock’s fair value from US$155 to US$185. “We remain impressed with Microsoft's ability to drive revenue and margins at this scale and we continue to believe there is more to come on both the revenue and margin fronts.”

The tech giant’s cloud service platform Azure is already an approximately US$7 billion business. As adoption of cloud services continues to deepen, Romanoff forecasts Azure to be “the single most critical revenue driver over the next 10 years, as hybrid environments (where Microsoft excels) drive mass cloud adoption.”

 

Alphabet Inc C  
Ticker: GOOG
Current yield: -
Forward P/E:   22.62
Price:  US $1,125.41
Fair value:  US $1,400
Value:  20% Discount
Moat:  Wide 
Moat trend:  Stable
Star rating:  ***
Data as of Mar 16, 2020  

Parent company of Google, Alphabet (GOOG) drives 99% of revenue from the world’s most widely used search engine, of which more than 85% comes from online advertising. The tech behemoth also generates revenue from sales of apps (Google Play), streaming business (YouTube), hardware (Chromebook, Pixel smartphones and smart home products), as well as its cloud service.

As a result of the resent market plunge, Alphabet stock shed as much as 12% in the last two weeks of February and was trading, as of March 16, at considerably below its fair value at US$1125. The company’s long-term fundamentals, however, remain intact. “Alphabet dominates the online search market with Google’s global share above 80%, via which it generates strong revenue growth and cash flow,” says a Morningstar equity report, assuring “continuing growth in the firm’s cash flow[and] leadership in the search market.”

The company’s sustainable competitive advantage is underpinned by technological expertise in search algorithms and AI (intangible assets), as well as its network effects inherent in Google search, Android, Maps, Gmail, and YouTube.

Tech innovation and greater adoption of mobile devices have increased screen time on mobile devices, pulling in advertising dollars. “Google’s ecosystem strengthens as its products are adopted by more users, making its online advertising services more attractive to advertisers and publishers and resulting in increased online ad revenue,” says Morningstar equity analyst, Ali Mogharabi, who recently raised the stock’s fair value from US$1,300 to US$1,400.

Mogharabi considers investments in futuristic projects -- digital health and self-driving cars -- attractive, noting “positive returns on Alphabet’s investments in moonshots could increase the company’s fair value estimate considerably.”

Editor’s note: The author owns a small position in shares of Apple and Microsoft.

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About Author

Vikram Barhat

Vikram Barhat  Vikram Barhat is a Toronto-based financial writer specializing in investing, stock markets, personal finance and other areas of the financial services industry. He also writes for CNBC, BBC, The Globe and Mail, and Toronto Star.

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