Are tech stocks alive?
If you own tech stocks, you have a right to feel nauseous. From the start of 2022 to mid-May, the QQQ Nasdaq ETF has plunged from $401 to $300. However, QQQ trades at a 4x PE while the Nasdaq is nearly 20x. Even a boring, steady bank stock like Bank of America trades above 10x. Is this a glimmer of hope for tech stocks?
By now, tech shareholders know all the reasons: hot inflation, rising interest rates, supply shortages, the Russian war in Ukraine, China’s lockdowns and inflation again. Powell hiking rates by 50 basis points wasn’t enough to soothe the market’s nerves. Instead, the market foresees an economic slowdown and a recession perhaps not this year, but possibly next. The jury is still out about, but April’s U.S. consumer inflation numbers came in a tick below the previous month’s (though still at 40-year highs). Maybe, just maybe we are passing peak inflation.
What I do know is that some megacap names released bad quarters in April (I’m looking at you, Netflix), while others delivered strong numbers. Microsoft delivered a fine top and bottom line beat. Meta reported more daily active users and strong cash flow. And Apple hit a homer. Initially, the reaction was good, such as Meta shares jumping 16% the morning after their report. However, all these names—good quarters and bad—have since been swept in the selling deluge that has gripped much of May. It’s been nearly a month after these quarterly reports, so let’s look at two big names with clearer eyes.
Overall, the quarter was mixed, though investors perked up on the daily active users numbers and the EPS beat of $2.72 above $2.56. The market bumped the stock from $174.95 to $205.73 the day after that report. Meta stocks are out of the dog house, and are attractive at a 15x valuation. However, it will be investing in the metaverse through 2030. Reality Labs, its VR research and development arm, suffered $2.96 billion in losses in Q1 compared to $1.83 billion the previous year. (Meta will lower operating expenses this year, though.) It’s too early to tell whether the metaverse will pay off or what it will even be. In the meantime, investors should keep in mind that Meta is a cash cow with an ad-driven business model generating $30 billion annually at a free cash flow yield of 11%. Sure, many governments hate Meta/Facebook, but it hasn’t stopped people from using it.
Meta stocks won’t stay at these price levels and shares will be higher a year from now. Also remember that Meta owns Instagram, which continues to thrive. Instagram’s Reels is competing directly with the popular TikTok. We’ll see if Reels makes a dent in TikTok’s market share. A possible headwind: a recession would squeeze ad spending by small businesses. That said, pick up some Meta stocks at these levels. It’s been oversold.
The world’s number-one streamer released its latest quarter on April 19 and it landed like a bomb. Shares tanked 25% the following day. IT came down to subscribers: a net loss of 200,000 in Q1 and a forecast of losing two millions subs in Q2. It was the first decline in subs since October 2011 and surprised the market. In fact, the company had projected an additional 2.5 million net subs in Q1. Netflix blamed rising competition, password sharing and the Russian war, though the street widely believes that the end of lockdowns is another big factor.
Russia accounted for 700,000 subs, said Netflix, while it reckons more than 100 million households are sharing passwords. More competition, said the company has increased their spending on shows and movies—Netflix’s bread and butter—but they had to hike rates to pay for that. The company admitted that that contributed to losing 600,000 subs in North America during Q1.
The quarter was not a complete disaster, however. EPS came in at $3.53 vs. the expected $2.89, and free cash flow topped $802 million in that quarter, up from $692 million a year earlier. Bulls will also point that there is a lot of room for Netflix to grow in Asia, in particular. According to Ampere Analysis, Asia accounts for 43% of the world’s subscriber base, compared to 29% being North America, 16% Europe and 8% Central and South America. In India, only 10% of households use a subscription streaming service. Ampere feels that Asia will grow the fastest in future subs.
Netflix has 220 million subs globally. It added 1.1 million in Asia during Q1 as it lost 1.3 million elsewhere. About 10% of overall revenues come from Asia.
The runway is potentially large, but the challenge though is local competition. There are dozens of streamers in Japan and South Korea (home to The Squid Game, Netflix’s most-watched show to date), 40 in Hong Kong and Taiwan and more than 70 across southwest Asia, according to Media Partners Asia. India alone boasts 80 streamers, even though Netflix has slashed rates. A key note is that streaming is relatively new in Asia, so viewers are still settling on their services, which is both a plus and minus for Netflix.
Credit Netflix for investing in these markets and expanding the taste for international fare worldwide. It has dropped more than $1 billion in South Korea alone, which produced Squid Game, and around $400 million in India in recent years. Netflix is the top streamer in many Asian markets, but India remains a crowded, but massive battleground.
In addition to Asian subs, other tailwinds include Netflix cracking down on password sharing (overdue in my opinion). Analysts have also suggested that Netflix offer live sports and videogames as well as a two-tiered system that includes ads and not. I’m not sure how subscribers will take to ads, though, since the benefit of streaming is no advertising.
Netflix remains the number one streamer in many markets, despite competition. It offers the best content (for adults) and the most. Apple and Prime create fine programming, too, but not on the scale of Netflix. Paramount+ is the newbie, so it’s too soon to judge that. True, these other services are cheaper, but you also get what you pay for. Disney+, however, may give Netflix a run for its money, because it has a lock on the Disney and Star Wars franchises which are universally loved or at least known.
Disney+ offers mostly family content, but there is also some significant adult fare, such as The Beatles: Get Back docuseries which made a splash last November. Disney+ also rivals Netflix in terms of breadth in its library. Then, there’s cost: Disney+ is the U.S. costs $7.99 a month but $79.99 a year while Netflix charges $15.49 monthly, the highest among all the streamers.
Netflix has been top dog, because it has been pumping out great content ever since Steve van Zandt’s brilliant Lilyhammer. But content costs big bucks, and Netflix’s pockets are shallower these days.
A macro tailwind favouring all the streamers is that inflation may discourage moviegoers from attending the cinema and stay at home to stream. This may happen less this summer because summer blockbusters tend to be the comic book movies that play well on a large screen in surround sound, but the trend may be pronounced in the winter.
So, where does this leave Netflix stocks? NLFX’s valuation has plunged below 16x and shares plunged over 75% by mid May to levels last seen since August 2017 below $165. Netflix stocks will not return to $700 anytime soon, but it’s too cheap. Shares are starting to climb towards $200. It’s been punished too much. Start picking away at it.