Buy these 16 cheap tech stocks with strong cash flow: Bank of America
- As the macro economy evolves, the end is near to tech’s decade-long outperformance.
- But Bank of America analysts say good opportunities still exist — if investors are selective.
- Investors should consider stocks with strong cash flows, which perform well during rate hikes.
After ten years of steady gains, the dizzying outperformance of tech stocks may finally come to a halt.
The perfect combination of tailwinds that once propelled tech stocks to dizzying heights is fading, said a team of Bank of America analysts led by Savita Subramanian, head of the company’s U.S. equity and quantitative strategy.
Factors that have characterized recent decades of equity investing include
, disinflation, near-zero interest rates, increasingly oligopolistic markets, and a shift in investment strategy from active to passive asset management, Subramanian wrote in the early June note. Taken together, these factors have contributed to long-term growth trends and given impetus to multinational companies that are disrupting the industry, creating the perfect environment for technology companies.
Unfortunately for tech investors, everything seems to be coming to an end.
“Tech was the best sector by far over the last decade, but peak liquidity, trough rates, inflation, passive funds
/crowding, anti-monopoly rumbles and proximity pressure pose risks,” Subramanian wrote.
Subramanian pointed out that the unraveling of globalization was the first of the woes of the technology sectors.
“Globalization has peaked and mentions of business relocation skyrocketed in the first quarter. Businesses have also become less dependent on Chinese imports since 2018,” she wrote. “Technology can be seen as the poster child for globalization, and it sports the greatest overseas exposure and the greatest exposure to emerging markets.”
Tech companies have also been hurt by the COVID-19 pandemic, which has created tough earnings scenarios for many companies as it drove consumer demand forward, Subramanian explained. And if history is to repeat itself, tech stocks will not fare well if the economy goes into a stagflationary environment spurred by the mounting oil crisis overseas, she added. During the historic periods of stagflation of the 1970s and 1980s, the technology sector was one of the worst performers.
But this decline in technology stocks, generally considered to be growth stocks, may also be part of a greater mean reversion. While growth stocks have taken center stage since the 2008 financial crisis, value stocks have generally outperformed since 1926, Subramanian pointed out. Additionally, as the cost of capital continues to rise, growth stocks will continue to suffer.
Selectivity is the name of the game
Still, that doesn’t spell the end for tech stocks, though it may take some time for the sector to regain its footing. After the dot-com bubble burst in 2001, Subramanian estimated that it took the industry about ten years to recover.
“In the meantime, we would be selective and take advantage of volatility,” she wrote. “We like some tech stocks, especially those that have moved into the top quintile of the market in terms of free cash versus enterprise value.”
A company free cash at enterprise valueor FCF/EV, indicates its ability to generate cash, and according to Subramanian, the metric is one of the top-performing indicators of the seventy tracked by his team.
This is also increasingly important as interest rates rise, as tech stocks with higher FCF/EV ratios typically perform very well in the first year of a hiking cycle, although ‘they lag behind when interest rates are close to zero and cash is “essentially worthless,” Subramanian explained.
To that end, Subramanian and his team have identified 16 “beaten” stocks in the technology and communication services sector that have both an FCF/EV ratio above 3% and a decline of more than 25% compared to their market highs, indicating a cheap valuation. The stocks are listed below in descending order of available cash versus company value, along with each company’s ticker and industry.