Mr Market’s stories follow stock prices, Scientific investors follow fundamentals

For 2022, the markets are down. The Nifty 50 is down by around 6% and S&P 500 is down by around 14%. However, the Nasdaq 100 and Nifty IT are both down by around 24%. As Mr. Market is wont to do, when stock prices are up, the stories are optimistic, and when stock prices are down, the stories are pessimistic.

With technology stocks, both global and Indian, in a bear market, it is no surprise that the stories doing the rounds are negative. The focus is on a US recession, which has “35% probability”; which actually means there is “65% probability” of US growth and no recession. US inflation and the US Fed’s interest rate hikes are “worrying”. The global supply chain disruption is a worry. The Russia-Ukraine war is a worry. Higher crude oil and commodity prices are a worry. No doubt all these are important factors and pose a risk to growth. But there is always a lot to worry. There was a lot to worry about in 2020 and 2021. Remember Covid? Global supply chains were disrupted throughout this period.
However, also consider, US unemployment is near an all-time low of 3.6%. US real GDP growth is expected to be nearly 3% and nominal growth at 7%. US employers are unable to find candidates, with many more jobs outstanding than the number of candidates available.

Many companies are reducing guidance since they would like to be conservative. Also, supply chain disruptions can have a revenue impact, especially for consumer goods companies, even when they have strong demand. Higher commodity prices can cause reduced margins. In prudence, companies would rather lower guidance now and get the benefit of beating guidance, if things turn out normal.

Now, moving to technology companies. US technology companies are down 24%. Many of these were “long duration” companies. These were hyper-growth, negative cash flow companies that were expected to become cash flow positive 10-15-20 years from now. The discounted cash flow-based valuation of such companies is highly sensitive to the discount rate. And the discount rate is related to the Fed fund rate or the risk-free rate. So the Fed announcing an aggressive interest rate increase path, causing the share prices of these companies to fall, is no surprise. However, in sympathy, or in contagion, even large Big Tech companies with very strong positive cash flows of billions of dollars also fell, taking down the Nasdaq-100.

(See disclaimer at the end) This makes large companies like Apple, Facebook (Meta), Google (Alphabet), Microsoft, Amazon etc. available at a price to cash flow ranging from as low as 9 to 32. Most of these companies are expected to grow in double digits, mostly on the higher side. The situation is similar with numerous smaller technology companies with positive cash flows and high growth rates. But they are all down.

Coming to Indian IT companies, the situation is even more bizarre. These companies have strong positive cash flows. They have high growth rates. Even a US recession is unlikely to have practically any negative impact on them. Their US clients are in the midst of a multi-year digital transformation cycle that cannot be stopped. The first leg of this is moving to the Cloud. The Cloud is growing at 20% according to Garner, but for Indian IT companies it is growing at nearly 40%. The deals and order books are in place and deal pipelines are strong. Customers would rather accelerate movement during difficult times, as observed during Covid. That the Cloud business is growing strongly can be confirmed from the guidance and outlook provided by cloud platform owners, such as Microsoft Azure, Amazon AWS, Google GCP and IBM. This can be confirmed from the outlook of Indian IT services companies such as TCS, Infosys, Wipro and the smaller firms.

However, Indian IT companies are still down. The Rupee depreciating against the Dollar is favourable to Indian IT companies. With the Fed increasing interest rates, even with the RBI following suit, it is likely to put pressure on the Rupee. This works in favour of Indian IT companies, both in revenue and margin terms.

It doesn’t make sense that one of the healthiest sectors in the Indian listed space should be down 24% when the overall Indian markets are down 6%. But rather than find reason in Mr Market’s whimsical mind, it makes sense to grab the opportunity, or at least consider it strongly, when it arises. Indian IT companies are available at PE ratios in the 20s, with expected growth rates in double digits. Even in a high interest-rate environment, this is probably fairly-priced or better. And these companies are providing exposure to themes such as digital transformation, cloud and metaverse.

Similarly, US technology firms — those with strong positive cash flows and growth rates — provide exposure to Artificial Intelligence, Internet of Things, 5G, Cyber Security, Blockchain, Metaverse, Digital Work, Digital Life, and many more interesting themes. And these too are available at attractive valuations from a long-term perspective.

Mr. Market is mispricing technology stocks in both India and the US. If it suits one’s investment objectives and risk profile, one can consider deep diving and building a portfolio or investing in a professionally designed portfolio of such companies. Such opportunities are relatively rare.

Disclaimer: Any mention of stocks, securities or ETFs is not a recommendation to buy, sell or hold. We or our clients may be buying, selling or holding the above-mentioned stocks and might change our opinions in future. Investing in equity markets is subject to market risks. Global investing has added risks, including country and currency risk. Investors should take the advice of their financial advisor and make investment decisions according to their individual risk profile and investment objectives.