It has been a very unkind two months for technology stocks in general. Due to high valuations, inflation fears, and hawkish comments from the Federal Reserve, the sector has been hit especially hard, after outperforming for the better part of two years since the pandemic.
Even after the sell-off, many tech stocks still trade at high valuations. But when a sectorwide sell-off occurs for reasons that have nothing to do with business fundamentals, it may be a good time to pick up shares of best-of-breed stocks set to grow handsomely over the coming years.
Here are three top names I'd feel comfortable scooping up heading into 2022.
High-growth, high-multiple software-as-a-service stocks have been among the most affected by recent market trends, CrowdStrike (CRWD 0.44%) included. Its stock is down about 30% from all-time highs set just one month ago. While that seems like a lot, there are a lot of high-multiple tech stocks that have fared much worse.
But this valuation de-rating doesn't have anything to do with the fact that CrowdStrike is a leader in the growing field of cloud cybersecurity, and appears to have a differentiated platform whose moat is getting stronger. Amid the drop in its stock price, CrowdStrike actually beat estimates for both revenue and its adjusted earnings per share in its fiscal third-quarter earnings release on Dec. 1.
On the conference call, management highlighted how CrowdStrike's unique platform landed a big customer win in the U.S. federal government. As we all know, the government has the highest standards for cybersecurity, especially under a new directive from the Biden administration, so that should only serve to further boost CrowdStrike's credibility.
Management also boasted that the CrowdStrike Falcon platform saw its win rates go up across both enterprises and small and medium businesses, as well as against both legacy cyber vendors and newer next-gen cloud upstarts. Specifically, the company took a jab at recent IPO SentinelOne (S 1.33%), which investors may view as its strongest competitor, with CEO George Kurtz saying, "We also landed a record number of wins and displacements over a recently public next-gen vendor, SentinelOne."
In fact, CrowdStrike has also differentiated itself among analysts. Although software analysts at JPMorgan and Chase recently downgraded several high-flying cybersecurity and cloud observability stocks to "underweight," this week, those same analysts actually raised CrowdStrike's rating to "overweight."
This differentiation versus peers makes me comfortable buying CrowdStrike again after its recent sell-off.
While software valuations have been coming down, lower-priced semiconductor stocks have actually been holding up just fine over the past month. One is semicap equipment leader Applied Materials (AMAT -1.93%), which has the broadest portfolio of equipment in the sector, with machines spanning etch, deposition, metrology, and inspection, across logic, memory, and display customers.
With the pandemic having accelerated digital transformation, and chip-intensive applications such as 5G, artificial intelligence, autonomous cars, and the metaverse coming to the fore, the long-term outlook seems very positive for chip growth and thus Applied Materials.
The semiconductor industry has been highly cyclical in the past, which is why Applied Materials only trades at 22 times trailing earnings and 18.7 times next year's estimates, which are below-market multiples.
However, it appears the demand for chip equipment is broadening and more strategic these days, which could make financial results more consistent going forward. Leading global foundries have all announced multi-year spending plans that are more strategic in nature, and most equipment companies are booked through 2022. Moreover, Applied Materials and its peers have all developed recurring services that should grow along with its installed base year in and year out.
Although Applied Materials slightly missed analyst expectations last quarter, the miss appeared to be purely a function of supply constraints, not demand. In its just-completed fiscal quarter, Applied Materials' revenue jumped 34% -- pretty good, but orders grew an even higher 62%, and semiconductor systems equipment orders were up 78%. So "light" revenue today, if one could call it that, should be filled in the next fiscal year, leading to "stronger for longer" demand.
Meanwhile, Applied's scale and limited competition enables it to gush cash, with operating margins hitting a record 32.9% last quarter. Applied Materials is using basically all its free cash flow to raise its dividend, which now yields 0.7%, and to buy back even more in stock.
Industry leadership, strong growth visibility, and lots of shareholder returns all make Applied Materials a tech stock you can buy without hesitation in this difficult period for tech stocks.
Finally, in contrast with my colleague Nick Rossolillo, I'm looking to buy more of Splunk (SPLK 2.42%), a leader in IT operations, cybersecurity, and observability management. If there is any company that could be considered a "value" stock in the software space, Splunk is it. Many of these fast-growing but profit-less stocks currently trade off sales, and Splunk trades at just seven times its sales figure. That's well below many of its peers that have price-to-sales ratios in the teens, 20s, 30s, 40s, or even higher.
Yet even Splunk's revenue figure underrates its business, because it's going through a big transition. Splunk was traditionally sold as perpetual licenses on-premises, and it's now moving to cloud subscriptions. When a company does that, its revenue can fall, as upfront payment for multiple years is replaced with lower subscriptions paid over time. A better indicator is Splunk's annualized recurring revenue, or ARR, which came in at $2.83 billion last quarter, versus just $2.52 billion in trailing-12-month revenue.
So why is Splunk's stock so cheap? There are a number of reasons. First, some may be focused on 19% revenue growth instead of the higher 37% ARR growth, and are uncertain about the transition to the cloud. Second, as the company makes the transition, there are certain one-time costs associated with moving huge workloads from data centers to the cloud. Finally, Splunk's CEO of six years just stepped down, leading to uncertainty about its leadership going forward.
As much uncertainty as there is, Warren Buffett once said that "you pay a high price for a cheery consensus." Meanwhile, Splunk's fundamentals seem solid. Its cloud bookings soared to 68% from 54% in the prior quarter -- a large jump that indicates it's succeeding in transitioning large company workloads to the cloud.
The cloud net expansion rate accelerated to 130%, which means customers that had already transitioned to the cloud a year ago are expanding their use of Splunk. So, it's not just new, incoming cloud transitions from on-premises data centers leading to this cloud growth.
On the CEO question, the company seems in good hands. Interim CEO Graham Smith has been on Splunk's board since 2011 and been Chair since 2019, and he was formerly the CFO of the original cloud-based SaaS company, Salesforce (CRM 0.46%).
Meanwhile, Splunk counts more than 90 of the Fortune 100 as customers, and mission-critical infrastructure and observability software vendors tend to be sticky. That's especially true for large, complex organizations, as Splunk helps its customers transition huge workloads to the cloud. The pessimism has gone too far, and the stock is a buy at these beaten-down levels.