Why are technology stocks falling – Inflation and tightening of the FED’s monetary policy, high valuation levels and greater regulation are the three keys, according to the expert

02/02/2022 –

MADRID. With January over, it can established that if a sector

Three factors pointed out to justify its negative evolution:

  • Inflation and tightening of monetary policy by the US Federal Reserve (FED).
  • High valuation levels achieved by the leading companies in recent months.
  • Regulatory tightening in Europe, China and the United States.

1) Inflation and tightening of monetary policy

One of the valuation methods frequently used by analysts is to project the financial statements of the companies they study to -subsequently- discount future flows to the present, typically free cash flow.

In the case of technology companies, this free cash flow has grown consistently and rapidly in recent times, and the analysts, in their models, have maintained the growth rates in many cases. They expected to generate increasing and high results over time.

Taking into account that when discounting the present value is more significant for the closest flows,  if the reference interest rates rise, analysts will have to adjust the discount rate upwards. This has the immediate effect that the present value of the flows obtained back in time will be lower; therefore, the estimated value for the analyzed society will drop.

2) High valuation levels achieved

Another concern among investors the valuation levels reached by many companies in the technology sector throughout 2020 and 2021, with the sector trading at multiples well above its historical average.

This second factor closely linked to the previous one. Until November of last year, few questioned, for example, the PER or EV/EBITDA at which technology companies, large or small, front-rank or not, were trading. In general, justification was found based on the future growth of these companies.

When the FED used that its monetary policies would be more restrictive , analysts incorporated the new situation into their models, reduced their forecasts, and lowered valuations and, th

Practically all the big technology companies have received downward revisions (although with some exceptions, minor adjustments). That kind of ‘running target pricing’ no longer seen behind prices that did not stop rising.

3) Regulatory tightening

The third factor and no less critical that negatively affecting the price of technology companies the regulatory tightening that being proposed against them, both in China and in the US and the European Union, seeking to pass laws that limit certain activities and businesses, especially of the largest groups (Amazon, Alphabet, Meta Platforms and the Apple app store).

For example, last week, a working group of US senators proposed an antitrust law prohibiting the most significant technology platforms from favoring their own crops and services to the detriment of the competition. In addition, lawmakers modified the bill to include a new provision designed to fit sizeable foreign-owned technology platforms, with the goal of something specific like TikTok.

The so-called ‘American Innovation and Choice Online Act’ will now go to the full Senate after several senators declared they wanted to include additional changes before voting in favour of the measure. The bill has bipartisan support, although there are discrepancies between politicians from both major parties. Its detractors point out that it a law directing particular companies (those previously mentioned) but that it allows another group of smaller companies to carry out the same behaviours that are being questioned for the large ones.

In our opinion,  the strong push made in the digitization of the economy makes the technology sector deserve a premium in its price compared to its historical valuations. Still, this premium could indeed excessively high, and now the context demands to much more selective in a sector which will maintain very high levels of growth in results; but that, unlike what happened a few months ago, will not always reflected in the prices.