Apple, Netflix to Amazon, Earnings Math Catches Up With the Tech Highflyers
Who could have foreseen the selloff in shares of big technology companies? Anyone who bothered to do a little math.
Technology shares are taking a historic beating. The average tech stock in the Russell 3000 Index is down 44% from its 52-week high, and many are down much more. Of the roughly 400 stocks in the sector, about a quarter are down more than 60%, most of them smaller companies. Big tech hasn't held up much better, though. Amazon.com Inc. is down 43% from its 52-week high. Netflix Inc. is down 73%.
The collapse of overhyped tech startups may not be surprising, but surely investors couldn't have anticipated that the tech powerhouses would receive similar treatment.
Or could they? When shares of Amazon began to buckle last July, they traded at more than 40 times Amazon's expected earnings for the current fiscal year. That's high even for a growth stock. The forward price-earnings ratio for the Russell 1000 Growth Index has averaged around 20 since 1995, the longest period for which numbers are available. (The average for the Russell 3000 Growth Index is the roughly the same, but the data set is shorter, back to 2006.)
Either Amazon investors were content to pay more than double the historical average for a growth stock or, more likely, they expected future growth to justify the company's outsized valuation. One way to gauge those expectations is to calculate the earnings implied by the stock price at a 20 multiple, the long-term average for growth stocks. By that measure, investors' expectations were ludicrous. To justify its 52-week high last July at a 20 multiple of forward earnings, Amazon would have to deliver profits of $187 a share. That's a long way from the $17 a share analysts expect Amazon to achieve this year.
How long? Analysts also expect Amazon's revenue to grow 12% this year, which is more than double the historical average revenue growth for the Russell 3000 Growth Index. Even at that higher pace and based on Amazon's historical average profit margin of about 3%, it would take the company more than two decades to generate earnings per share of $187. And that may be optimistic because it's not easy for a company as big as Amazon to maintain that level of revenue growth.
For perspective, consider that since 1995, it has taken an average of four years for earnings to catch up to expectations baked into the Russell 3000 Growth Index, and most of the time less. Investors don't hang around much longer, and in extreme cases they can change their minds quickly. At the peak of the dot-com craze in 1999, a 20 multiple for the growth index implied earnings of $33 a share, nearly three times the index's earnings for the previous fiscal year. Profits would have had to grow by at least 27% a year to catch up with expectations in four years or less, nearly four times the index's historical average earnings growth of 7% a year.
Once investors realized that their growth expectations were beyond reach, they ran for the exit. The Russell 3000 Growth Index plunged more than 60% from peak to trough over the next two years, bringing its valuation and earnings expectations down with it. Those who bought the growth index in 2002 after it sold off waited only two years for earnings to catch up with expectations, whereas those who bought in 1999 and stuck it out waited 16 years.
Amazon investors have been more patient, waiting on average seven years for earnings expectations to materialize, but even they have their limits. Those who paid a fortune for Amazon stock in 1998 had to wait 20 years for earnings to catch up, but there probably weren't many because the stock lost 98% of its value from 1999 to 2001. As with the broader growth index, investors who bought the stock in 2002 at a more reasonable valuation waited just two years for their earnings expectations to be realized.
Amazon investors still expect too much, even after the stock's sharp decline. Shares of Amazon now trade at 54 times this year's earnings. Even if profits bounce back next year, as analysts expect, the stock could trade closer to 30 times, which is no bargain.
The same analysis applies to Netflix, except that Netflix now trades at 17 times this year's earnings, down from more than 50 a few months ago. Netflix should have little trouble delivering the growth investors expect from its current valuation. The same could be said for Google parent Alphabet Inc. and Facebook parent Meta Platforms Inc., which trade at 18 and 14 times this year's earnings. Apple Inc. isn't far off at 22 times.
But Amazon isn't the only holdout. Among the giants, Tesla Inc. still trades at 55 times this year's earnings, and Salesforce Inc. fetches 34 times. Don't be surprised when investors decide that the remaining highflyers won't live up to lofty expectations soon enough, either.
Nir Kaissar is a Bloomberg Opinion columnist covering markets. He is the founder of Unison Advisors, an asset management firm.