Markets continue to struggle because high inflation must be fought with brute force. That’s a stark reality for the inflated values of large-cap tech stocks that are going through a 1973-74-style bear market. the Nasdaq’s decline of -10.5% for April may be modest.
Amazon (AMZN) earnings showed what inflation means for the company’s “sum of the parts valuation”. The stock fell 15%, lowering the PE multiple to 70.5 times current earnings, which is still double the future earnings multiple at 35 times. Even that valuation is high, and considering the stock has more downside as demand for services slows.
The risk is a spread below $1956/share, which is still 55.8 times current earnings (Figure 1).
Figure 1: Multiple Amazon PE Bands
During the 1956 action, all pandemic-inflated valuation is removed. Yet Amazon’s valuation is still 23% overvalued according to Discounted Cash Flow (“DCF”). Amazon’s leverage has increased to 1.9x forward 12-month EBITDA, while the cost of capital/discount rate is estimated at over 7%. The stock is oversold but exhibits more negative valuation metrics (see Figure 2).
Figure 2: Amazon DCF estimate
For the market, this is the day for calculating the market cap weightings of big tech in the S&P index. Prior to the pandemic, FAANG’s market cap weightings in the S&P traded in the 1-3% range. In 2019, that changed with Apple (AAPL) gaining market leadership with a 7% market cap weight from the S&P. While Amazon has clearly lost the race, it’s Microsoft’s (MSFT) market cap weight in particular that can’t keep pace with Apple (see Figure 3).
Figure 3: Historical FAANG market cap weightings in the S&P 500
Even though Apple is strong in terms of fundamentals, it is not trading above 12-month forward price targets. It deviated significantly from Amazon, which also remained below analysts’ 12-month futures price targets. The risk is that Apple may have the same faith as Amazon when one of its quarterly results is missing.
Cook & team’s warning that the supply chain and strong dollar could hurt earnings leaves the stock vulnerable to a sudden 15% drop like Amazon, especially as expectations for Apple’s performance remain high despite the technology bear market (Figure 3).
Figure 3: Apple and Amazon vs. 12-month price target
Apple’s DCF analysis shows an even worse overvaluation of 37%, while Wall Street targets are up a steep 23% to $196/share on average. The intrinsic value is $125/share, 22% less than the current stock price. (Figure 4).
Figure 4: Apple’s DCF valuation
The stock is trading at the lower end of multiple PE bands with a decline of $136/share at 22x earnings (Figure 5). Apple is as exposed as Amazon and other FAANGs to excessive downselling.
Figure 5: Apple PE multiple bands
For the markets, the “internals” are hard hit because even though Amazon’s market capitalization weight is down, the stock hit the consumer discretionary 5% hard in Friday’s session. The decline in FAANG market cap weights may continue if the DCF and intrinsic value analysis are correct.
Still, a silver lining is that the S&P and big tech are seeing a reduction in over-concentration, which (eventually) drives valuations back to much better entry-point levels. Moreover, the sensitivity of big technologies to interest rates is beginning to diminish.
The duration of bond indices – a measure of sensitivity to rates affecting bond prices – is falling, and this will continue as yields hit 3.5% for Treasuries (Chart 6). The promising news is that return volatility may recede, which has plagued big tech stocks.
April turned out to be the S&P’s worst monthly return since 2002. But it’s worth noting that the VIX and VXN (Nasdaq’ VIX) were stuck below the critical stress level of 40. This is a sign that the broad index is in a range rather than a broad bear market.
Tech can regain some momentum, provided supply chain, labor shortages, inflation and the dollar don’t worsen. The valuation is a cause for concern, but the downward multiple adjustment also shows that the market is paying attention to valuable parts of the valuation that are getting cheaper, although they are not very attractive yet.
Figure 6: Duration of the bond index (years)