Over the past six months, small and mid-sized technology stocks have outperformed mega-cap technology stocks. The 11% rally so far this year in the Nasdaq 100 Stock Index ($IUXX) (QQQ) has stretched the valuations of large technology stocks, prompting some investors to look toward smaller companies that may be lower profile than their mega-cap peers but which offer cheaper valuations and stronger growth prospects.
Valuations of mega-cap technology stocks have become elevated. Megacap technology stocks have a multiple of 23 times future earnings, above the 10-year average, while the S&P 400 Midcap Information Technology Index trades at about 18 times future earnings, below its 10-year average. The S&P SmallCap Information Technology Index is trading in line with its long-term average.
Newtown Investment Management says the economic backdrop favors smaller-cap stocks in the technology sector. “The valuation gap between large caps and other sizes has reached such an extreme that by itself it creates a favorable backdrop for small versus large for the foreseeable future.” According to Bloomberg Intelligence, small-cap technology companies are expected to average 5.1% revenue growth in 2023, compared with just 0.1% for the S&P 500 technology sector.
Some analysts are urging investors to look beyond mega-cap technology stocks, saying valuations and earnings estimates have bottomed for small and mid-cap stocks, creating an attractive entry point. For example, JPMorgan Chase said the biggest declines in earnings revisions “have been in small-cap equities, and the pain has been so acute that we’re starting to see a bounce higher. Also, valuations for both small- and mid-cap companies have corrected to levels we usually see during recessions.”
Another boost expected for small and mid-cap technology stocks is increased acquisition activity. In 2022, technology was the only sector that saw an increase in M&A activity, while total U.S. transactions dropped -31%. Spouting Rock Asset Management expects M&A to continue to act as a tailwind for small caps, especially in the software sector. “There are attractive companies out there with good growth outlooks and valuations, and we’re seeing private equity take advantage. Small caps are a great place to shop right now, and tech looks as attractive as ever,”
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On the date of publication, Rich Asplund did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
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