“A rose is a rose is a rose,” poet Gertrude Stein wrote in 1913.

Many conservative investors have long applied this view to tech stocks, tarring them all with the same brush of pricey risk. Yet the heightened contrast created by the current valuation scenario may prompt such investors to see that a tech stock is not a tech stock is not a tech stock.

The existing valuation gap between high-multiple, low-earning tech companies and those with real earnings has widened into a chasm over the last 18 months, as the average P/E for the Nasdaq 100 has declined. After rising steadily from 2010 to 2020, this multiple started coming down in mid-2020. Recently, this downtrend has accelerated as the Nasdaq and the S&P 500 have corrected. As of mid-February, the forward P/E of the Nasdaq 100 was about 25.5—below pre-pandemic levels.

Declining prices and rising earnings among quality tech companies has imbued them with an unlikely value-esque character. Though prices of tech companies with no or low earnings have also fallen, their multiples remain at nosebleed levels, sustaining the classic image of tech risk.

The attractive terrain of the earnings dispersion is heavily populated by semiconductor industry companies, though other types of tech are there, too. That chip companies are heavily represented on the desirable side of the earnings chasm is no surprise, considering short supply and pressing global demand from use in everything from data centers to cars to toasters to toilets (yes, toilets). Despite high earnings, the Philadelphia Semiconductor Index has underperformed the S&P 500 year to date.

The opposite extreme of the earnings dispersion is populated by high P/E, earnings-challenged companies like Snowflake and Zscaler. Just as the Icarus, a character in Greek mythology, fatally flew too close to the sun on wings coated with wax, such companies are still soaring perilously high on the wings of over-investment.

TARP
Broad earnings dispersion has given high-earning, lower-P/E companies a new patina of value that I call TARP—tech at a reasonable price (not to be confused with the Troubled Asset Relief Program of 2008). TARP stocks might hold interest for conservative, value-oriented investors who have long approached tech with trepidation. Yet now that P/Es are much lower among quality tech companies, such clients might find see the wisdom of making or increasing investment in tech.

Of course, the virtues of TARP aren’t going unnoticed by institutional investors. “In a rising rate environment, earnings will set you free because, if they are there, the multiples eventually get to a point where somebody sees value and steps in make the other side of the trade,” said David Lebovitz, global market strategist for JP Morgan Asset Management.

In an analysis designed to identify TARP stocks with long-term viability, my firm put tech sector companies through proprietary screens to find those with the lowest downside risk. Then we ranked the resulting firms in order of average annual projected EPS growth over five years (as determined by analysts’ averages from Factset).

High Earnings, Lower Risk
Micron Technology, the semiconductor memory technology and production company, led the pack with projected annual EPS growth of 27.65%. Next came chip manufacturer Qualcomm (17.46%), followed by chip-manufacturing software and equipment supplier Applied Materials (16.39%); KLA Corp., producer of chip-manufacturing process-control systems (15.98%); and Lam Research, supplier of chip fabrication equipment (11.53%).

The relatively low-risk/projected high earners identified weren’t just chip industry companies. Also in this select group were the boring yet resurging software giant Oracle (11.16% projected annual EPS growth) and connectivity sensor firm TE Connectivity Ltd. (10.42%). Reflecting their stability, all the stocks in this performance group pay a dividend—the highest from Qualcomm, with a yield of 1.65%.

While Micron led in projected earnings, it has a bit more downside risk (along with substantially higher volatility) than the others in this generally low-risk roster. By the same measures, Applied Materials, KLA, Oracle and TE Connectivity (10.42% projected annual EPS growth) have the lowest risk levels. 

Notably, all the companies in the high-projected-EPS group in late February had 12-month trailing P/Es below the S&P 500’s P/E of 24.3, as of 2-24-2022. So did Cisco, Texas Instruments, IBM, Intel, Dell and Hewlett-Packard. Yet each of these six lower-risk companies have lower projected annual EPS growth, too—all below 10%.

Ironic Comparisons
The earnings dispersion has produced the ironic result of making TARP a better value opportunity than materials or energy. And considering the historical volatility of tech, that’s saying something. Yet materials and energy can also be quite fickle. And their regulatory risk makes them inferior long-term investments to TARP. 

There’s also a lot of talk these days about financials, but studies show that this sector tends to peak about a year before interest rates do—timing that doesn’t bode well these days as the Fed cranks up for a series rate increases.

Lastly, it’s hard to overstate the impact of the digital revolution, which may prove the most impactful industrial revolution ever. It will drive the overall market higher as we move through this century’s third decade.

Of course, the impactful nature of digital advancement has never been in doubt. The problem has been valuation and now, this problem is at an advantageous pause. Many investors wouldn’t stop pouring money into the sector when P/Es were much higher. Why would they back off now that some names are in the sweet spot of lower prices with high earnings? 

As TARP prices are pushed up, the current valuation window, naturally, will soon close. 

David Sheaff Gilreath is CIO and a partner of Innovative Portfolios, an institutional money management firm, and of Sheaff Brock Investment Advisors. Based in Indianapolis, the firms managed about $1.4 billion as of December 31, 2021.