There is broad euphoria in large cap technology shares globally, and I strongly believe profits should be taken. My AIM Global High Conviction Fund has sold the vast bulk of our technology holdings and today I want to tell you why you should also be taking profits in Tencent (700.HK), a stock I recommended in these notes earlier this year, which has gained +75%.
To set the scene, it needs to be made clear that the gains in large cap technology shares globally HAVEN’T been driven by earnings growth. The majority of the share price gains have been driven by P/E expansion with investors paying higher and higher multiples for earnings streams. This is a dangerous situation and one that can easily reverse if investor sentiment changes.
Put simply, technology earnings multiples have generally increased at a faster rate than earnings momentum. We highlight the same in a table below of a handful of large cap U.S. tech stocks. Within the well-followed FAANG stocks, for example, only Netflix has seen earnings revisions (F12M upgrades of c.60%) re-rate at a faster rate than multiple appreciation (c.20%). In contrast Google’s multiple has increased by 23% off just 9% higher F12M EPS revisions. The same can be found from more ‘traditional’ tech (Oracle for example) to new thematic leaders such as in eGaming (e.g. Activision). Oracle has seen 11% EPS revisions, 25% multiple appreciation and the stock has risen 31% YTD. Activison has seen just 6% EPS higher revisions, a 55% multiple appreciation and a stock price 69% higher than at the end of 2016. Now that we are in the midst of the Q2 earnings season, it feels as if a general tone of ‘beat and raise’ is not quite enough to see fresh impetus to take the sector to new highs short term. Technology stock volatility has also notably increased in recent weeks and many investors bought into the positioning of certain areas of the technology sector very late.
While we do feel that the technology sector offers more earnings power than many other sectors of the economy, we certainly don’t ascribe to the idea that the rising tide should lift all boats from here.
However, it is not only high-profile U.S. technology stocks that had seen their multiples re-rate at a higher velocity than the underlying earnings estimates had. The same can be said about a number of high profile Asian technology stocks. See the table below: from Norther Trust.
Source: S&P Capital IQ, Northern Trust Securities LLP
Tencent, for example, has seen its 2017 P/E multiple increase by 31% YTD, versus small single digit consensus upgrades to EPS. Tencent is in an investment year in 2017, but the point is that for those stocks where there is a significant gap between the two metrics, we wonder if we may see some pressure on stock prices in the short term. No doubt the digital scale platform titans, such as Tencent, Alibaba and Facebook, deserve premium ratings, but they will need to “grow” into such ratings rather than skyrocket higher.
Tencent’s share price is now ahead of itself and it’s time to take profits.
The stock is +74% in 2017 alone and on technical analysis is on a massively bought RSI of 77.
2017 P/E has risen from 28 to 45
2017 Consensus EPS has risen from $5.85 to $6.31 (+7.8%)
Analysts are “EUPHORIC” with 45 Buy recommendations, 2 Holds and 0 Sells. Analysts are also now in a competition to have the highest share price target.
Click here for a larger image.
A year ago when Tencent was the biggest holding in our portfolio, we would go around doing presentations to investors and advisors about the investment case and the vast bulk of people had never heard of the stock. Fast forward to today and TENCENT is now very well owned and very well known. Even above you can see 45 broking firms write positive research on the stock. It has been discovered, it’s widely held, but it’s now expensive and it’s time to take profits.
I also want to be VERY clear that I am now outright tactically bearish on technology shares globally and locally. The premium they are commanding to the broader equity markets is now too stretched versus their earnings growth outlook. The risk of a genuine correction is real and present, led by the NASDAQ. Note well that NASDAQ heavyweights Amazon and Alphabet both fell more than 6% since reporting Q2 earnings below expectations.
I tend to believe you are watching the “peak on euphoria” moment again in technology stocks. They have sucked everyone in right at the highest multiples ever and it’s time to move to the sidelines for a while and wait for better risk adjusted entry prices.
While the easiest sector narrative of all is technology, that leads to it being the most over-owned and over-priced sector anywhere in equity markets. I say again, the risk of a genuine correction is real and present, led by the NASDAQ.
P/E expansion is “hot air”. Hot air can be deflated very quickly.
If you followed my buy recommendation on Tencent and have made a nice return, I encourage you to take profits and wait for a better risk adjusted buying opportunity. That opportunity will come and it’s now time to be disciplined and patient in all technology shares.
I’ll keep it short and to the point today. Take profits in Tencent and be careful in large cap technology shares. A correction is coming.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
