By Doug Zeisel, TCV Growth Partner-
Wow, it seems like the party is over for bitcoin and blockchain investors. Is this the dot com bubble bursting all over again? It sure seems like it with Bitcoin down by 67% in past year and Coinbase Global down nearly 80%. Then look at META Platforms aka Facebook – down 71% over the past 12 months. And the big tech heavy NASDAQ index is down 29% over the same time period. UGLY! This dismal performance begs a few questions – why did this happen? Is it time to buy? Where are their bright spots?
Let’s start with the first question. At its peak just before the Coronavirus Pandemic hit in 2020 the NASDAQ was trading at about $9,700. It then crashed to about $6,200, a decline of 36% in March 2020. What happened next was a flood of money into the economy by the Federal Reserve via asset purchases and by the Federal Government via free money. The economy was awash in liquidity and a lot of that excess money found its way into the stock market. Remember all those Reddit fans? Investing in technology became a fad and the NASDAQ nearly tripled from its bottom to a top of $16,212 reached just 13 months after the bottom. That’s an almost unheard of increase and brought the Price/Earnings ratio to just over 30. Tech stocks were wildly overvalued unless one assumed that real interest rates would remain below zero forever (obviously not the case).
Remember growth stocks are typically valued by a discounted cash flow model that discounts anticipated future earnings by an equation that puts the sum of future earnings in the numerator and a discount factor based on interest rates in the denominator. The smaller the denominator, the larger will be the end value of this computation. The Federal Reserve had pushed interest rates down so much that future calculated values went crazy high. But it made no sense to assume interest rates would stay so low unless there would be zero economic growth. So when inflation got out of hand (which it always does when the government floods the economy with money) the Fed had no choice but to raise interest rates. The denominator goes up and anticipated values go down. So where are we now? The NASDAQ is trading at a PE multiple of 22.5, a decline of 25%. But is it enough? That answer depends on how far interest rates will increase. Back in 2014 the NASDAQ PE ratio hit a low of 14.4 so there is still room for further decline.
But there are many interesting tech companies selling for a fraction of their all-time highs reached just over a year ago. While it may be too soon to call a bottom and hindsight sight is 20/20, consider companies that you understand the value of the technology and have growing sales with a low Price to Sales (PSR) ratio. Three keys:
1. Is there an obvious value proposition? After all, no matter how fascinating the technology if it doesn’t save time, money or solve a problem, the technology is worthless. So be sure you understand the value the company brings to its markets.
2. Yes, we may not have hit the bottom of this market cycle because inflation is still not under control which means that the Federal Reserve will continue raise interest rates. So average into a position of your favorite tech company’s stock buying a pre-determined amount over the next 12 months.
Remember, market timing is a matter of luck as much as anything so an average position is likely to be a good position.
3. Diversify – This age old strategy means that you need to have holdings that are in diverse industries. You can look for tech companies that provide cost savings or more efficient operations in Finance, Energy, Heavy Industry, Healthcare, etc. Here are some examples:
> Silvergate Capital – yes it’s a bank holding company (Silvergate Bank) but it’s also getting into cash management services for digital currency related businesses. So if you believe that digital currencies have a future, here is a less volatile way to invest in that concept.
> Sabre Corporation – Sabre provides software and tech solutions to the travel industry. While an upcoming recession may put a dent into travel, Sabre continues to sign up new customers who will provide leverage when travel rebounds.
> Accolade Inc. – Has a technology that helps people navigate our complex healthcare system and their workplace benefits. Their platform is cloud based and offers support from a variety of health assistants. Most recent year over year quarterly revenue growth was almost 20%.
> Tenable – This Columbia MD based cyber security firm has year over year revenue growth of 26% and half a billion dollars of cash on its balance sheet and while it is still showing a quarterly net loss, it has operating positive cash flow. Tenable provides real time vulnerability assessment to its large and growing client base.
So what’s hot?
According to the Wall Street Journal the biggest challenge Chief Information Officers see for the next year is no surprise, cyber security. Companies in this industry should see increasing revenues even in a recession year. Speaking of recession, many companies are already cutting expenses but one area that should hold up well are companies whose technologies save their customers money, thereby making the purchase of their products a net gain.
Yes, we cannot predict whether this market has hit bottom yet, but if you like tech a gradual accumulation of tech companies with a wide range of industry customers offer limited diversification. BTW, Doug Zeisel holds small positions in two of the companies mentioned in this blog post.