The dreaded coronavirus pandemic continues to take a heavy toll on equity markets, with major indices well into bear-market territory. The Federal Reserve has cut interest rates to zero, and this news failed to reassure investors.
COVID-19 has caused mayhem in China, and similar declines can be expected in other countries that are struggling to contain the virus. According to China's data from Trading Economics, in the first two months of 2020, the country's retail trade fell 20.5%. Industrial production was down 13.5%, and fixed-asset investment plunged 24.5%.
So how should investors trade in such a volatile market? Well, for one, they need to avoid tech stocks that are trading at high valuations. Tech stocks tend to outperform the equity markets in a bull run but grossly underperform in a broader market sell-off.
Stock valuations come crashing down in a downturn and expensive tech stocks are hit the hardest. Here, let's look at three such companies that might underperform the S&P 500 if the sell-off continues.
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As enterprises and consumers are expected to reduce spending in the first two quarters of 2020, there is a good chance that company or consensus forecasts for the upcoming quarters will need to be revised downwards. I will hence focus on the trailing 12-month multiples instead of forward-looking ratios.
A digital advertising pioneer
Shares of digital ad-buying company The Trade Desk (TTD -3.66%) are trading over 50% below record highs. Despite this massive decline, the stock continues to trade at a premium. The Trade Desk is valued at $6.6 billion or 19.6 times 2019 sales. The stock has a price-to-earnings multiple of 63.6, which is well above other companies in the S&P 500.
During the company's earnings call last month, management was largely confident about growth prospects despite the increasing fears of COVID-19. But a lot has happened since then, especially after the World Health Organization formally declared the outbreak a pandemic.
One way the company may stand to "benefit" from the outbreak is the increase in media consumption with the global population opting to work from home. This may drive ad-spending higher, but it is quite possible for enterprises to cut marketing spend at a time where consumer demand is expected to fall drastically.
TTD is a leader in programmatic advertising, and its long-term prospects over the next decade remain promising. However, stocks with lofty multiples experience greater volatility and shares could remain under pressure in the near-term.
A cloud communications platform
Shares of Twilio (TWLO -0.72%) are also trading 50% below record highs. The company has a 2019 price-to-sales ratio of 12.2. Twilio's cloud platform can handle billions of text messages, voice calls, videos, and emails for mobile applications.
The company has billion-dollar companies such as Lyft, Twitter, and Airbnb as customers. Now, COVID-19 has brought the travel and tourism industry to a standstill. This means companies such as Lyft and Airbnb will experience a drastic fall in customers, which may indirectly affect Twilio's top line.
While Twilio's revenue grew 75%, its operating loss more than tripled to $369.8 million in 2019. Investors would like to invest in stocks with robust cash flows and strong profit margins in a volatile macro environment, and Twilio isn't quite there yet.
A digital publishing giant
Shares of Adobe (ADBE -1.32%) are nearly 25% below record highs. The stock recently reported stellar quarterly results. In the fiscal first quarter of 2020, Adobe's sales were up 19%, while its adjusted earnings per share jumped to $2.27.
Adobe stock is likely to be the least affected by COVID-19 compared to the other two companies on this list. However, Adobe shares are still expensive at the current price. Adobe has a market cap of $145 billion and a price-to-sales ratio of 13, and is trading at a trailing price-to-earnings multiple of 44.6.
In the first quarter of fiscal 2020, Adobe's digital media business reported annualized recurring revenue (ARR) of $8.73 billion, driven by demand for mobile applications including Photoshop on iPad, Lightroom, and Photoshop Express.
Another important metric for a SaaS (software-as-a-service) business is the increasing backlog revenue or remaining performance obligation (RPO) that grew to $9.91 billion in the first quarter.
The verdict
The three companies mentioned here are market leaders in their respective industries, which has resulted in a multi-fold increase in stock prices over the years. While the fundamentals of all three tech companies remain solid, there is a serious concern over high valuations in a market that can nose-dive within the next month.
The Trade Desk, Adobe, and Twilio remain winning bets for the long term, but there is an opportunity for investors to buy them at a lower prices if the bear market continues to persist.
