Why Goldman Sachs Thinks Technology Stocks Are In Very Serious Trouble

The ten year bull market that started in March of 2009 when the S&P 500 hit the ominous intra-day low of 666 is the second longest bull market on record, and while stocks have basically traded sideways over the last 18 months, there are signs that the market may be ready to crack. Technology stocks, especially the FANG stocks, which include Facebook, Amazon, Netflix and Google have driven market performance for years, and this year is no exception, with technology up 22% versus the S&P 500’s 15%.

One of Wall Street’s highest profile firms, Goldman Sachs, is sounding the alarm and with good reason, as they noted recently that valuations are extremely high, with software stocks now carrying their highest multiples since the dot.com tech bubble that finally imploded in 2001. In addition, the technology sector as a whole trades two standard deviations higher than the ten year average. In statistics, the standard deviation is a measure that is used to quantify the amount of variation or dispersion of a set of data values. The Goldman team noted this in the recent report.

The lofty current valuations of Software stocks reflect the voraciousness of investors today for stocks with strong secular growth prospects. Growth stocks have outperformed dramatically in 2019, with our long/short growth factor returning 7% year-to-date, and 22% since the start of 2017. This dynamic is not unusual late in the economic cycle, when investors are typically willing to pay a premium for idiosyncratic growth as economic activity decelerates. In addition to growth, investors have embraced software firms due to their above-average profit margins as well as their relative insulation from trade conflict.

David Kostin, who is the chief equity analyst at the firm cited in a recent note to clients multiple reasons for investors to be concerned, not the least of which is the current sky-high multiples and pressure from Washington D.C., where many are calling for anti-trust regulations for the technology giants. Recently, Facebook co-founder Chris Hughes, in a scathing New York Times editorial said founder Mark Zuckerberg is much too powerful, and the social media behemoth should be broken up.

The report also noted that historically, stocks with the highest enterprise value to sales ratios ended up underperforming peers on a longer term basis, and while they delivered the same upside that cheaper stocks provided when beating growth estimates, they also had far more downside risk when missing estimates.

While Goldman Sachs is very cautious on some of the mega-cap technology companies, they remain positive on growth stocks that have reasonable valuations. The firm screened the Russell 3000 looking for stocks that had at least $1 billion in market capitalization, and the following metrics:

1) Positive sales growth in each of the past three years, averaging at least 10%

2) Consensus 10%+ sales growth in each of the next two years

3) Consensus 2019 net profit margins greater than 10%

4) Forward enterprise value to sales ratios below 6 times

5) Low regulatory risk based on share of industry U.S. sales

The screen came up with 21 companies primarily in the technology and healthcare sectors, we found five that are the most well known that still look like outstanding picks for growth accounts looking to stay invested, but wanting to distance themselves from some of the high-flying technology giants.

Advanced Micro Devices

This top chip company has turned the corner, and may be the best semiconductor buy now. Advanced Micro Devices, Inc. (NYSE: AMD) is one of the largest suppliers of PC microprocessors and graphics processors worldwide to computing OEMs. The company’s main product lines include desktop, notebook, server, graphics processors and embedded/semi-custom chips.

The Wall Street consensus price target for the stock is posted at $29.97. The shares closed Tuesday above that at $30.45.

Diamondback Energy

This stock is a top Permian Basin play for more aggressive accounts and is a potential takeover candidate. Diamondback Energy, Inc. (NASDAQ: FANG) is an independent oil and natural gas Company headquartered in Midland, Texas focused on the acquisition, development, exploration and exploitation of unconventional, onshore oil and natural gas reserves in the Permian Basin in West Texas.

The Wall Street consensus price objective for the company is posted at a stunning 155.45. The stock closed Tuesday at $104.54.

Lululemon Athletica

This is a top yoga apparel retail stock that is continuing to expand their product offerings to a very loyal customer base. Lululemon Athletica Inc. (NASDAQ: LULU) is a Vancouver, Canada-based specialty retailer that sells technical, high quality, and premium-priced athletic apparel through its own stores and websites.

Founded in 1998 in Vancouver, Canada, the brand began as a line of clothes made out of technical fabric. Today, lululemon has over 400 stores in Canada, U.S. Asia, Europe and Australia and is poised for significant expansion.

The consensus price target across Wall Street is posted at $186. The stock closed trading on Tuesday in line with the target at $184.34.

Palo Alto Networks

This company continues to be one of the most dominant players in the cyber security industry. Palo Alto Networks, Inc. (NASDAQ: PANW) is helping to lead a new era in cyber security by protecting thousands of enterprise, government, and service provider networks from cyber threats.

Unlike fragmented legacy products, their security platform safely enables business operations and delivers protection based on what matters most in today’s dynamic computing environments: applications, users, and content.

The consensus price objective is set at $265.88. The shares were last seen Tuesday at $205.35.

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Ulta Beauty

If there is any company to own in the retail sector, this may be the one. Ulta Salon Beauty Inc. (NASDAQ: ULTA) is a holding company for the Ulta Beauty group of companies. The Company is a beauty retailer and offers cosmetics, fragrance, skin, hair care products and salon services.

Ulta offers approximately 20,000 products from over 500 beauty brands across all categories, including the Company’s own private label. The Company also offers a full-service salon in every store featuring hair, skin and brow services.

The Wall Street consensus price objective is set at $361.56. The shares closed Tuesday reasonably close to that level of that level at $347.21.

The bottom line for investors is the market is fully valued, we are definitely in the late-cycle economically and for the stock market, and while improving somewhat, the trade and tariff issues are still front and center. Finally, with an election coming next year, you can count on white-hot rhetoric from both political parties.

It makes sense to move from many of the pricey tech stocks to growth stocks like the five we listed, which offer far better valuations.