Why some technology companies should be on your radar as low-risk stocks

Highly profitable U.S. mega-caps such as Apple and Microsoft are falling with everything else, presenting an opening for bargain hunters

The market mayhem of the past week has followed a pattern: Tech stocks are getting hit, and trendy tech stocks with scant profitability, or none at all, are getting hit the hardest.

But highly profitable U.S. mega-caps such as Apple Inc. and Microsoft Corp. are being dragged down with everything else during this tumultuous period, handing investors an opportunity to start their bargain hunting with the big shots.

For sure, it’s not easy buying into a dip that may not be over. The Nasdaq Composite Index has declined 14.6 per cent since the start of 2022, after encouraging rebounds early on Wednesday and Thursday fizzled. That marks its worst start to a year since 1972, according to Bank of America.

Among some of the more notable casualties, online trading platform Robinhood Markets Inc., central to the meme stock trading phenomenon, has declined 34.9 per cent this year. Peloton Interactive Inc., which makes fitness products, has declined 33 per cent.

And Zillow Group Inc., the online real estate marketplace, has fallen a further 26.7 per cent after a steep decline in November.

The sell-off, which has ensnared stock markets worldwide, follows expectations that the U.S. Federal Reserve will raise its key interest rate as soon as March. On Wednesday, the central bank said in its policy statement that it will “soon be appropriate” to raise its key rate, reinforcing market expectations for as many as four rate hikes in 2022.

Higher interest rates weigh on the attractiveness of future cash flows, and growth stocks – whose profits may be years away – are particularly vulnerable. Higher interest rates can also slow economic growth, raising uncertainties about companies without consistent track records.

Microsoft and Apple don’t really fit this profile, though: They’ve been around for decades, are exceptionally profitable and their valuations aren’t absurdly high.

Yet, the stocks have been caught in the downdraft. Microsoft has fallen 11 per cent in January. Apple has fallen 10.6 per cent, and has recorded its first correction – a decline of at least 10 per cent from a recent high – in about a year.

These declines look out of place next to the companies’ stellar profit growth.

After markets closed on Tuesday, Microsoft reported its profit in the past quarter, ended Dec. 31, surged 21 per cent from last year, to US$18.8-billion.

That was ahead of the average profit estimate from analysts, and it reflected solid gains in revenue from cloud services and Windows licensing. As well, gaming revenue rose 8 per cent, ahead of Microsoft’s offer last week to acquire game developer Activision Blizzard Inc.

For Apple’s most recent quarter, the company reported late Thursday that revenue increased by 11 per cent from the same period a year ago, even as it struggled with supply chain issues that have bedevilled other manufacturers. Profit rose to US$2.10 a share, well ahead of analysts’ expectations and up 25 per cent from last year.

But even as these two behemoths produce dazzling financial results, valuations appear reasonable for bulletproof technology companies. Microsoft shares trade at 32 times trailing 12-month earnings – not a steal, but slightly below the five-year average of 35 times trailing earnings.

“We believe Microsoft’s ability to sustain robust growth and profitability is still not properly reflected in consensus estimates or valuation,” Phil Winslow, an analyst at Credit Suisse, said in a note this week.

The stock trades at about 28 times estimated 2023 profit from RBC Capital Markets.

Apple trades at 28 times trailing earnings. While that is at the high point of its five-year range, it is in line with Nasdaq’s priceto-earnings ratio of about 26, and cheap next to many of the flimsier technology companies – not to mention meme stocks – that have been hit far harder during recent market volatility.

Some observers expect that the turbulence of the past week will reward lower-risk stocks with consistent profit growth. Big Tech fits that description nicely.