Earnings Now Matter for Technology Stocks

As interest rates continue to climb, technology stocks that surged during the low-interest rate era are now falling back to earth as investors realize that profits matter. Unprofitable technology companies that have underperformed this year will likely continue as a slowing economy, and the threat of recession makes them a riskier bet than usual. 

Goldman Sach’s non-profitable basket of tech stocks containing non-profitable U.S. companies in innovative industries has plunged -57% this year.  In comparison, the Proshares S&P Technology Dividend exchange-traded fund (ETF) that focuses on dividend-paying companies in the industry has fallen only -22% on a total-return basis this year, while the Nasdaq 100 Stock Index ($IUXX) (QQQ) has dropped -32%.

The slump in technology stocks this year has come as the Fed has aggressively raised interest rates to combat inflation, a headwind to technology stocks priced on their prospects far out in the future.  Ameriprise Financial said, “there may come a time where unprofitable companies outperform again, but I don’t think Fed policy or the market backdrop will favor them anytime soon.  We think they’re in for more pain until we see inflation moderate and the Fed slows its pace of rate hikes.”

The focus on profitability for technology stocks is a sharp reversal from pandemic-era trends when ultra-low interest rates and economic stimulus fueled outperformance in hyper-growth stocks. Goldman Sach’s basket of non-profitable tech stocks soared more than 400% between a low in March 2020 and a peak less than a year later.  The basket has since plunged -73% from that high.

While the recent selloff in tech stocks has compressed their price-earnings multiples, KeyBanc Capital Markets said many unprofitable tech companies continue to trade at sky-high valuations, notably high-growth software stocks.  Winslow Capital Management said they favor profitable tech giants like Microsoft (MSFT), Amazon.com (AMZN), and Alphabet (GOOGL), saying, “we wouldn’t branch out into unprofitable tech. Eventually, high-growth unprofitable stocks will come back, but we wouldn’t expect that for a long time.”  

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