The Nasdaq has risen nearly 40% since the beginning of the year as investors warmed up to higher-growth tech stocks again. However, many investors might be reluctant to chase that rally as interest rates stay elevated.
Those fears are justified, since high interest rates usually deflate the valuations of pricier stocks.
But a closer look at the tech sector finds that plenty of promising stocks are still trading at reasonable valuations. I personally believe that Meta Platforms (META 0.43%), Alphabet (GOOG 9.96%) (GOOGL 10.22%), and DigitalOcean (DOCN 3.30%) are all still fantastic deals in this recovering market.
Image source: Getty Images.
1. Meta Platforms
Meta was one of the market's most-seriously challenged tech stocks of 2022. Its shares sank to a seven-year low last November as investors fretted over the slowing growth of its advertising business, stiff competition from ByteDance's TikTok, platform-related issues caused by Apple's iOS changes, and its stubborn commitment to burning billions of dollars in its Reality Labs division.
Those challenges caused Meta's ad revenue to decline year over year for three consecutive quarters before it finally returned to growth in the first and second quarters of 2023. It now expects total revenue to rise 15% to 24% year over year in the third quarter, which would represent a significant acceleration from its 11% growth in the second quarter.
Meta's growth accelerated again as Chinese cross-border marketplaces ramped up ad spending on Facebook and Instagram to reach more overseas customers.
Meta also continued to expand its short-video platform Reels to counter TikTok, and it rolled out new AI-driven ad tools to circumvent Apple's privacy-oriented changes on iOS. The recovery of its advertising business stabilized Meta's margins and enabled the company to continue subsidizing the Reality Labs segment's loss-leading strategies.
The 3.88 billion people who use at least one of Meta's main apps (Facebook, Messenger, Instagram, and WhatsApp) monthly should make it a market-leading advertising platform for the foreseeable future. Analysts expect its revenue and earnings to grow 12% and 50% respectively this year -- yet its stock still isn't expensive at 26 times forward earnings.
2. Alphabet
Alphabet's stock also dropped to its lowest levels in nearly two years last November. At the time, investors weren't impressed by the cooling growth of its advertising business in a tougher macro environment.
YouTube's decelerating ad sales were particularly disappointing, since they suggested it was struggling to keep pace with TikTok and other video platforms.
Google's advertising revenue declined year over year for two consecutive quarters before returning to growth in the second quarter of 2023. That recovery was driven by a stabilization of the broader advertising market, and the company expects its development of new AI tools and large language models to widen its moat against newer generative AI chatbots like ChatGPT.
The growth of Google's nonadvertising businesses also accelerated as it gained new YouTube Music and Premium subscribers and rolled out new Pixel devices.
Google's cloud business continued to generate high-double-digit sales growth over the past year, even though it still controls a much smaller slice of the cloud market than Amazon and Microsoft. Google Cloud has also maintained positive operating margins over the past two quarters.
Analysts now expect Alphabet's revenue and earnings to grow 7% and 22%, respectively, this year, as the macro environment gradually improves. Those are solid growth rates for a stock that trades at 23 times forward earnings.
3. DigitalOcean
DigitalOcean is a cloud infrastructure services provider that slices out tiny "droplets" of its servers for smaller businesses. That approach enabled it to carve out a defensible niche between Amazon, Microsoft, and Google in the cloud, since all three market leaders mainly serve large enterprise customers instead of tiny start-ups.
Most cloud infrastructure companies experienced slower growth over the past two years as the macro headwinds forced enterprise customers to rein in their software spending. Yet many smaller businesses continued to ramp up their usage of DigitalOcean's services throughout that slowdown. As a result, DigitalOcean's revenue rose 35% in 2021, grew another 34% in 2022, and it expects 22% to 25% growth this year.
The bears initially claimed DigitalOcean would struggle to stay relevant against its larger competitors in the public cloud market. However, its adjusted gross margin; adjusted operating margin; earnings before interest, taxes, depreciation, and amortization (EBITDA) margin; and free cash flow (FCF) margin all constantly expanded over the past year.
Those rising margins indicate DigitalOcean still has plenty of pricing power in its niche market, and the company's recent acquisition of Paperspace could help it keep pace with the cloud giants by integrating more GPU-powered AI features into its servers.
DigitalOcean isn't profitable by generally accepted accounting principles (GAAP) yet, but I believe it has a bright future, and its stock looks reasonably valued at 6 times this year's sales.
