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The Nasdaq Is Down From Its Highs -- Is It a Good Time to Buy Tech Stocks?

By Nicholas Rossolillo - Apr 7, 2021 at 7:30AM

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Tech is the future, and some growing names are on sale.

The Nasdaq Composite is up over 50% since the start of 2020, so it's no surprise the technology-heavy index had a pullback in March. The Nasdaq was down about 10% from all-time highs at one point, although it has since started to rally back toward its peak levels.

But some individual tech stocks remain down far more than that, with some especially hard-hit names tumbling 30%, 40%, or more in value. The gradually reopening economy is to blame -- the epic stock price runs some tech outfits notched during the start of the pandemic simply weren't sustainable.

But growth isn't over. On the contrary, many tech stocks are buys after taking big hits during the first quarter of 2021. 

Tech is a long-term secular trend

The technology industry is now in a multi-decade long run higher, and there's no sign it's about to let up anytime soon. Though many firms got positive bumps from the pandemic last year, those same firms are expecting further expansion into 2021 and beyond.

Someone on a laptop. A video conference with nine other people is displayed on the screen.

Image source: Getty Images.

Zoom Video Communications (ZM 4.55%) is one prominent example: After an incredible 326% revenue increase in 2020, the initial outlook for the next year is for sales to increase about another 42%. That's a big cool off, but 42% annual growth when lapping a year in which tens of millions (if not hundreds of millions) of people were forced to start using online video for the first time is nothing to get upset about. 

Tech isn't just a secular investment trend in the traditional sense of the word, either. Amazon demonstrated how tech could disrupt the status quo in the massive retail industry, and other companies are starting to follow suit in other segments of the economy. Firms like PayPal Holdings (PYPL 0.37%) and Square (SQ 7.00%) are attacking banking and financial services, Teladoc Health (TDOC 5.65%) is changing the way patients access healthcare, and The Trade Desk (TTD 5.83%) and Magnite (MGNI 8.60%) are helping the TV industry transition to the digital age. Incidentally, all of these stocks are down double-digit percentages from all-time highs, even though their expansion is expected to continue for the foreseeable future. 

Granted, technology stocks are notorious for their lofty valuations, but they can be purchased for a premium for good reason. These are the future leaders of the economy, and they will continue to grow for a long time. Pullbacks are just buying opportunities if you have the time to wait. 

Betting on a more efficient world

Tech has always been about increasing efficiency. At some point in the ancient past, the wheel was technology aimed at making transportation faster. The industrial revolution of the 1800s, which produced breakthroughs in mechanized manufacturing and new power sources, equated to massive increases in productive output and could have been categorized as technology if such a term were in use at the time. 

Today it's all about software and computing power, especially delivered via the internet in the form of cloud computing services. And just like the tech of the past produced efficiency gains, so too do today's advances in software and computing.

Let's use Zoom Video again as an example. The communications industry isn't new. We've been able to stay in touch with others via the phone for a century. But Zoom builds on this and adds video into the mix. And as with other cloud computing services, it's easy to scale -- which means fat profit margins. Zoom generated free cash flow of $1.39 billion last year, good for a free cash flow profit margin of 52%. 

Is this an extreme example? Perhaps. It wouldn't be fair to expect Zoom to maintain such a high-profit-margin profile forever. Free cash flow generation will likely moderate along with its growth rate. However, Zoom does illustrate how transformational cloud services are. More traditional communications companies -- like mobile providers AT&T and Verizon -- operated at a free-cash-flow profit margin of around 16% last year. 

Granted, Zoom needs the lower-margin infrastructure services that companies like AT&T and Verizon provide in order to operate at all. But the financials speak for themselves. High-tech is also high-profit, and that's worth investing in.

Be mindful of the volatility

High growth and increasing profit margins don't absolve stocks from some wild swings in price. Technology names in particular could continue to exhibit above-average volatility this year as they start to lap the initial effects of the pandemic that started last March. As their growth rates moderate, be ready for some further pullbacks.

But that doesn't mean tech stocks aren't a buy if you have time to ride out the storm. With many names down by big double-digit percentages after the "crash" last month, now is a good time to start buying for the long-term (think at least a few years, but the more the better).

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Stocks Mentioned

Zoom Video Communications Stock Quote
Zoom Video Communications
ZM
$107.00 (4.55%) $4.66
NASDAQ Composite Index (Price Return) Stock Quote
NASDAQ Composite Index (Price Return)
^IXIC
$11,434.74 (0.00%) $0.00
Magnite, Inc. Stock Quote
Magnite, Inc.
MGNI
$10.61 (8.60%) $0.84
PayPal Holdings, Inc. Stock Quote
PayPal Holdings, Inc.
PYPL
$80.42 (0.37%) $0.30
Teladoc Health, Inc. Stock Quote
Teladoc Health, Inc.
TDOC
$33.45 (5.65%) $1.79
Block, Inc. Stock Quote
Block, Inc.
SQ
$83.41 (7.00%) $5.46
The Trade Desk Stock Quote
The Trade Desk
TTD
$49.03 (5.83%) $2.70

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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