Should Investors Be Worried About Tech Stock Valuations?

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For years, hearing news outlets call tech stocks “overvalued” has been normal. But when was the last time you heard someone argue that they were actually undervalued? While many people agree with the former camp, I place myself in the latter. While I won’t blindly label every tech stock as undervalued, there are multiple examples of segment leaders with cheaply valued stocks.

Three undervalued stocks are Shopify (SHOP 6.51%), Adobe (ADBE 3.17%), and Alphabet (GOOG 3.82%). These three companies dominate their respective industries yet have seen only disdain from the market over the past six months. 

Image source: Getty Images.

Shopify

Shopify provides software to power e-commerce businesses of all sizes. For example, businesses can process credit card payments and manage their inventory with Shopify’s platform, starting at just $29 per month. This stock resonated with investors during the pandemic and caused its valuation to explode higher.

SHOP PS Ratio data by YCharts.

After the pandemic skyrocketed Shopify’s price-to-sales (PS) ratio, the stock now trades around the same level as it did during 2017. Since then, Shopify has become profitable and has grown its gross merchandise volume (GMV) from $26 billion in 2017 to $175 billion in 2021.

For 2022, management expects growth to be faster than that in the larger e-commerce industry, but slower than the company’s 2021’s clip of 57%. Q1 will be the toughest comparison of the year, but by Q4 Shopify’s metrics will look better. The market may react negatively to Shopify’s Q1 report on May 5 if growth slows, but investors can use this short-term pessimism to their advantage if the long-term outlook is still solid.

Shopify has established its place as a top e-commerce player. Investors should be looking to get in with the stock down more than 70% from its all-time high.

Adobe

While Shopify is still rapidly growing and working toward full profitability, Adobe is already there. Its digital media product suite is a staple in nearly every business. Adobe has a wide product field with offerings ranging from Photoshop to e-signature solutions.

While Adobe reported a mediocre first quarter (ending March 4) with only 9% year-over-year revenue growth, it gave upbeat Q2 guidance with projected sales growth of 13%. Regardless, from a price-to-free cash flow perspective, Adobe is priced at the lowest since 2018.

ADBE Price to Free Cash Flow data by YCharts.

Adobe’s management recognizes its stock is undervalued: In the first quarter, it repurchased 3.8 million shares for $2.4 billion. Adobe is a category leader but is priced like it will lose significant market share or report no growth. Investors should take advantage of the market’s gift and purchase this fantastic business.

Alphabet

I saved the best for last. Alphabet is genuinely one of the most undervalued stocks in the entire market. With brands like Google and YouTube powering the business, many people interact with its products daily. Each owns a majority market share in their respective categories, making these two platforms advertising magnets. In the fourth quarter of 2021, these two platforms generated more than $50 billion in revenue for Alphabet.

In inflationary times, advertising becomes even more critical. With fewer dollars to go around, brands must make sure they are at the top of consumers’ minds. Because of this trend, Alphabet should have another solid year. Yet its valuation is criminally low. 

GOOG PE Ratio data by YCharts.

While the graph is skewed because of some odd earnings during 2018, Alphabet’s price-to-earnings (PE) ratio is historically low. A PE of 22 is about the same level as that which established companies like Home Depot (20) or Johnson & Johnson (24) trade around.  But compared to its tech giant peers Apple (28) and Microsoft (30), Alphabet is significantly undervalued.

Growth stocks can be had for pretty cheap in today’s market, something that isn’t often said. The last time the Fed raised interest rates was in 2018, about the same time these stocks reached their multi-year valuation lows. Because the stocks are trading in the same range now, investors shouldn’t be worried about buying an “overvalued” stock.

While nobody should purchase a stock based solely on valuation, investors can find several bargains such as these in the tech sector.