Stock Investing

This may be a good time for long-term investors to take advantage of lower entry points.
By Vikram Barhat | 11/04/18

The return of volatility to the U.S. and global stock markets has rattled investors everywhere. The start of the new quarter saw U.S. stocks slide into correction territory, triggering widespread panic and a knock-on effect on financial markets globally.

About the Author
Vikram Barhat is a Toronto-based financial writer specializing in investing, personal finance and small business. His experience working in various editorial capacities in digital and print media spans 15 years across three continents. He is also a former content editor of Advisor's Edge and Advisor.ca. He can be reached at vikrambarhath@gmail.com.

The tech sector, which constitutes about a quarter of the market capitalization of the S&P500, remains one of the hardest hit. It suffered heavy selling sparked by a cascade of negative headlines raging from President Trump's repeated bashing of Amazon to Facebook's data breach and fears of rising trade tensions between the United States and China, the world's two largest economies. A clear reflection of the sector's bumpy ride can be seen in the Morningstar U.S. Technology Index which has fallen more than 5% year-to-date (expressed in U.S. dollars) as of April 3.

There's little doubt, however, that the current spike in stock market volatility and tech rout will ultimately prove irrelevant for patient and pragmatic investors. In fact, as the market slide gathers momentum, long-term investors should stay calm and instead use the sell-off to their benefit.

The wild swings in prices of some of the blue-chip tech stocks as a result of panic-selling have caused mispricings, which have made these high-quality names cheaper. This may be a good time for long-term investors to take advantage of lower entry points and top up their portfolios with these large-cap tech heavyweights.

 

Facebook Inc. A
Ticker:FB
Current yield:-
Forward P/E:22.8
Price:US$158.57
Fair value:US$198
Value:19.9% discount
Data as of April 6, 2018

With more than 2 billion monthly active users,  Facebook (FB) is the world's largest online social platform. In addition to the Facebook app, its ecosystem includes Instagram, Messenger, WhatsApp and a host of features surrounding these products. Advertising represents more than 90% of the firm's total revenue, with 50% coming from the U.S. and Canada, and 25% from Europe.

The sharp contraction in Facebook's stock price recently was triggered by the data leak scandal which fuelled privacy concerns among users. However, Morningstar equity analyst Ali Mogharabi says "the firm is more likely to endure the short-term impact of the issue and we do not expect a significant long-term negative effect." Maintaining his US$198 fair value estimate for the stock, he insists that although the social media giant faces some downside scenarios, much of it is priced into its shares which, having cratered more than 15% over the past few weeks, represent "an attractive buying opportunity."

The exponential growth in user base and user engagement, coupled with the valuable data that they generate, makes Facebook attractive to advertisers in the short and long term. "The combination of these valuable assets and expected continuing growth in online advertising bode well for Facebook, as the firm generates strong top-line growth and remains cash flow positive and profitable," says a Morningstar equity report.

The wide-moat tech leader will continue to benefit from a greater allocation of marketing and advertising dollars toward online advertising, specifically mobile and social-network ads, says Mogharabi, who projects a five-year annual revenue growth rate of 22%.

 

Amazon.com Inc.
Ticker:AMZN
Current yield:-
Forward P/E:144.9
Price:US$1,431.62
Fair value:US$1,600
Value:10.5% discount
Data as of April 6, 2018

One of the world's highest-grossing online retailers, with US$178 billion in net sales in 2017,  Amazon.com (AMZN) recently overtook Google to become the world's second most valuable company, after  Apple Inc. (AAPL). Online retail sales accounted for 61% of 2017 revenue, while third-party seller services (18%), Amazon Web Services (10%), Prime membership fees and other subscription-based services (6%), Whole Foods and other retail formats (3%) made up most of the rest.

The stock has plummeted precipitously of late on jitters caused by U.S. President Donald Trump's frequent criticism of the tech giant.

"Amazon is the most disruptive force to emerge in retail in several decades," says a Morningstar report. "Its operational efficiency, network effect, and a brand intangible asset built on customer service provide it with sustainable competitive advantages that few, if any, traditional retailers can match."

Amazon will continue its market dominance through the convenience of Amazon Prime's expedited shipping, expanding digital content library and new partnerships coming out of its US$13.7 billion Whole Foods acquisition. One of Amazon's key advantages -- its operational efficiency of its fulfillment and distribution network – "allows Amazon to generate strong cash flow, which in turn can be reinvested in advertising, customer service and website enhancements that keep its marketplace robust and customer loyalty strong," says Morningstar sector strategist R.J. Hottovy.

The online retailer's competitive position and compelling value proposition should lead to additional share gains in 2018, notes Hottovy, who recently raised the stock's fair value from US$1,250 to US$1,600, prompted by a lower effective tax rate, more optimistic five-year revenue growth (around 21% annually) and margins estimates, and greater cash-flow.

 

Microsoft Corp.
Ticker:MSFT
Current yield:1.83%
Forward P/E:22.37
Price:US$91.61
Fair value:US$106
Value:13.6% discount
Data as of April 6, 2018

A global leader in software, hardware and services,  Microsoft (MSFT) operates in three segments: productivity and business processes (including Microsoft Office and Dynamics), intelligent cloud (including Azure and Windows Server OS) and personal computing (including Windows Client, Xbox, Surface, phones and Bing search advertising).

"Following the lead of new CEO Satya Nadella, Microsoft has embraced changes that will leave the firm better positioned for long-term, sustained success," says a Morningstar equity report, noting that the company has become nimbler and more user-friendly, which will help maintain its leadership status for years.

Of particular note is the durable, elevated growth rates of its cloud properties, which represent a monumental opportunity for Microsoft as new workloads increasingly shift to the cloud. "Microsoft has quickly emerged as one of the most important cloud computing firms in the world," says Morningstar equity analyst Rodney Nelson, who recently raised his estimate of the stock's fair value from US $100 to US$106. "Azure, the firm's public cloud service, has established itself as the number-two player in the space behind Amazon, and the platform should continue to garner significant user growth."

The wide-moat tech heavyweight's rich set of software and tools help keep developers in the ecosystem. "The company's massive enterprise footprint across a multitude of products and services creates a network effect around its productivity apps and operating systems, [resulting] in significant customer switching costs," says Nelson.

CEO Nadella's cloud-first, mobile-first vision for the firm is beginning to take hold, and the company is making the appropriate investments to reinforce its competitive positioning, he adds.

 

Alphabet Inc. C
Ticker:GOOG
Current yield:-
Forward P/E:24.9
Price:US$1,018.55
Fair value:US$1,200
Value:15.1% discount
Data as of April 6, 2018

Internet giant Google's holding company,  Alphabet (GOOG) generates 99% of its revenue from the search engine, of which more than 85% comes from online ads. Sales of apps and content on Google Play, YouTube Red and cloud service fees are other revenue sources for Google. The tech firm is also heavily investing in smart homes (Nest), digital health (Verily), Internet access (Google Fiber) and self-driving cars (Waymo).

The recent tech rout has taken nearly all tech majors down, including Google which has so far fallen more than 16% off its January highs, as of April 3. However, the tech behemoth's business fundamentals remain strong and firmly position it for a long-term growth and market leadership.

Google dominates the online search market with an 80% share, which helps generates strong revenue growth and cash flow, Mogharabi says in a Morningstar report, adding that "Google will maintain its leadership in the search market [and we] foresee YouTube gradually contributing more to the firm's top and bottom lines."

The wide-moat company's robust competitive advantage is built on technological expertise in search algorithms, copious amounts of user data and the network effect it derives from search, Android, Maps, Gmail and YouTube. "Google's ecosystem strengthens as its products are adopted by more users, making its online advertising services more attractive to advertisers and publishers, resulting in increased online ad revenue," says Mogharabi, who puts the stock's fair value at US$1,200.

The firm benefits tremendously from newer tech trends such as faster internet connections and greater adoption of mobile devices. "The online advertising market has taken notice and is following its target audience onto the mobile platform," says Mogharabi, forecasting double-digit-revenue growth through 2022.

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