The stock market has been pulled down over the past few months amid fears of higher interest rates and a potential economic slowdown. While the S&P 500 is down only 7.7% from its all-time highs, the tech-heavy Nasdaq has had a much bigger decline of 15.3%.
Yet the most compelling long-term opportunities should still come from tech-enabled innovation, and marketwide pullbacks are usually a great opportunities to pick up shares for the long term. Three top tech leaders are Microsoft (MSFT 0.37%) in enterprise software, Applied Materials (AMAT 1.46%) in semiconductors, and Sea Limited (SE 2.03%) in emerging market e-commerce, and each stock looks like a bargain today.
Microsoft
Even the biggest "safe haven" in technology, Microsoft, has pulled back 17.8% from all-time highs amid the recent downturn. Yes, the 10-year Treasury Bond has increased to over 2.8% this year, up sharply from 1.6% to start the year as the Federal Reserve is tightening financial conditions. That higher rate should put some pressure on stock valuations, depending on what investors were using as their baseline discount rates and equity risk premiums.
Yet Microsoft's current earnings yield is 3.35%, with its current P/E ratio of 29.8. Considering Microsoft has a higher credit rating than the U.S. government, its earnings yield could probably at least be the equivalent of Treasuries. That's because Microsoft's earnings should grow by double digits over the next several years and maybe longer, powered by the company's wide-moat software franchises.
Last quarter showed Microsoft's transformative technology on display, with its Azure cloud platform growing 46%, Office productivity software growing 14%, and Dynamics resource planning suite growing 29%. All applications delivered via Microsoft Cloud were up 32%. Meanwhile, Microsoft has other impressive growth businesses outside of enterprise computing, including LinkedIn, up 37% last quarter, the Bing search engine, up 32%, and even Microsoft's Xbox franchise, which grew 10% on top of difficult comparisons to the pandemic-era gaming highs. With several dominant franchises, it's also a good bet Microsoft can raise prices across its portfolio if need be in order to combat inflation.
Microsoft's diverse and highly profitable business should trade at an above-market multiple and arguably a lower earnings yield than government rates, so today's pullback seems like great buying opportunity -- as long as interest rates don't get too out of control.
Applied Materials
Another stock participating in the current technology supercycle is Applied Materials, the largest and most diverse semiconductor equipment stock, which makes highly advanced machines used to produce the world's chips.
It's surprising to this investor that semiconductor equipment stocks have sold off not only harder than the overall market but even harder than the general semiconductor index this year. This is despite their having high returns on capital, less competition, and lower valuations than chip designers. But hey, no one ever said the market was totally rational!
Image source: Getty Images.
It is true that semiconductor equipment investment has been cyclical in the past, but the industry has seen higher highs and higher lows each time. That seems more like an "uneven growth" rather than purely cyclical stock, because semiconductor sales are growing faster than GDP, and should for some time. Yet after the market's downturn, Applied Materials is down 30% from its highs and trades at just 15.8 times earnings. That compares with a 24.8 P/E ratio for the S&P 500 and a 31.9 for the Nasdaq 100.
With Applied's multiple half of the average tech stock, investors seem to fear an impending semiconductor downturn as the Federal Reserve increases interest rates. Yet based on recent commentary from Taiwan Semiconductor Manufacturing, the world's largest foundry house, on its April 14 earnings call, these fears appear unfounded. Amid a barrage of questions from analysts on a potential macroeconomic slowdown, TSM said it would not change its investment plans in equipment this year -- and was even worried it wouldn't be able to find enough machines to support its growth plans for next year.
That doesn't seem like there's any sign of an impending downturn to me. This is because high-performance computing, 5G communications, the Internet of Things, and autonomous vehicles have growing amounts of semiconductor content within each unit. So even if PC units cool off, which many are now fearing, the trend to more intensive computing should allow semiconductor investment to grow. Leading foundries have all announced long-term strategic investment plans spanning several years, which are unlikely to change much based on starts and stops in the economy.
Basically, investors are mistaking Applied Materials for a cyclical business, when it looks more like a secular grower worthy of a much higher multiple. That makes it a bargain.
Sea Limited
Among the worst-hit stocks amid rising interest rates are high-growth stocks currently generating hefty losses, such as Sea Limited (SE 2.03%). But if the growth opportunities are in fact as large as investors expected for Sea when its stock was triple the current price last November, the current price, down 70% from its highs, could end up being a bargain.
It's true that Sea's biggest cash cow, its Garena gaming unit, should see a decline in 2022 as the world emerges from COVID and the company's smash hit Free Fire matures. But given its ability to publish and develop hit games, Sea's gaming unit should grow over the medium term beyond 2022.
Yet Sea's biggest growth opportunities lie in its Shopee e-commerce platform and SeaMoney fintech unit, which are poised for another year of incredibly high growth, but are still unprofitable. Shopee has catapulted to become the No. 1 e-commerce platform across Southeast Asia, where internet penetration and e-commerce usage had been low prior to the pandemic. Now that Shopee has taken off in the region, management expects Shopee not only to grow 75.7% this year on top of 136.4% last year, but also for the unit to achieve positive EBITDA (earnings before interest, taxes, depreciation and amortization) in Southeast Asia by the end of this year. SeaMoney is also taking off, expected to grow 155.4% in 2022, with management guiding for cash flow profitability in 2023.
Sea did just pull out of India because of local regulatory hurdles, but that may not be a bad thing. Shopee is expanding rapidly in Brazil, where it is still generating hefty losses, and it may be a better idea to concentrate on a few of the most promising market opportunities and get more efficient in the age of higher interest rates. The e-commerce potential in both Southeast Asia and South America is large enough for lots of growth in the years ahead, as eight of the 10 fastest-growing e-commerce markets are either in Southeast Asia or Latin America. Beating competitors in these attractive markets, Sea is a compelling opportunity after its massive pullback.
