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Which tech stocks hold promise?

Which tech stocks hold promise?

Technology companies have had a truly stellar run.

Covid accelerated that. Yet so far this year tech has had a torrid time, with concerns about inflation and US rate hikes weighing heavily. Nasdaq is down 30 per cent year to date, more than reversing its 21 per cent jump in 2021.

Many of the tech names that outperformed throughout the past decade have seen the steepest falls. Some have seen 70 per cent or more wiped off their values since the start of the year, depending on the sector.

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Shares in technology giants Netflix and Meta dropped 70 per cent and 51.5 per cent, respectively, over the first half of 2022, while 'at-home' tech companies like Zoom and Peloton are down around 36 per cent and 73 per cent. Even Apple and Google’s parent company Alphabet have seen shares slide around 20 per cent.

While many would argue a correction has been on the cards for some time, the speed and depth of this correction has caught many off guard, triggering a period of shell shock in many private company boardrooms, as well as venture capital funds and private equity funds. This is particularly true for companies and founders who only started after the last correction in 2008.

In valuation terms we are now back to 2018-19 valuation levels. The sell-off has largely erased the pandemic premium, when tech valuations rose significantly as digital-first businesses achieved consistent growth, while other economic sectors stagnated or reversed. Although there has been a lot already written about the negatives, as with previous market downturns context and perspective are essential.

Venture capital firms are re-evaluating

Low interest rates and an abundance of investors had made it easy for tech entrepreneurs to launch and grow businesses in the past decade, but the savage drop in valuations and level of economic uncertainty mean VC firms are re-evaluating investments plans.

Whenever there is a crash, investment from VC and PE fund investment slows significantly as they sit back and take time to reflect on the market. This gives them the opportunity to assess which companies in their portfolio need help.

However, this is more difficult if the portfolio comprises many business-to-consumer companies that can be severely and more quickly hit during a recession.

The dotcom period showed just how sensitive VC investment is to market downturns. When the bubble burst in the US, VC investment dropped by about 42 per cent in just one quarter at the beginning of 2001, according to figures from the OECD. By the end of the first quarter of 2003, venture investment had fallen by a massive 85 per cent from the first quarter of 2000.

Historically, VC and PE have thrived after recessions and market disruptions. So despite the economic downturn we could soon see a pick-up in VC and PE investment as lower valuations make more and more investment ‘sense’.