U.S. tech stocks have gotten extremely expensive. The big-name tech companies (i.e., NVIDIA, Apple, Microsoft, and Meta) are all trading well North of 30 times earnings, while some smaller ones like Palantir (NASDAQ: PLTR) are at 60 times sales!
I’m not saying that U.S. tech stocks are necessarily overvalued today. However, the further their prices rise, the lesser the odds that they will continue to rise further. We are currently in the midst of a two-year bull market in tech stocks that shows no signs of slowing down. In fact, you could argue that we are in a 16-year bull market in tech stocks, one that was interrupted very briefly in 2018, 2020, and 2022 but never seriously challenged as a long-term trend. The periods just referred to were technically “bear markets,” but they didn’t last long. The 16-year trend is clear.
You have to wonder how long this party can go on for — the U.S. tech sector is currently valued at an amount approaching that of U.S. GDP. That doesn’t mean a bear market is a near-term certainty, but on a long-term basis, these valuations could cause some problems. In this article, I will explore why U.S. tech stocks have gotten so expensive and why “this time isn’t different.”
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46 times cash flow
According to CSI Market, the U.S. tech sector is currently trading at 46 times cash flow. The company’s report does not state whether it is talking about operating cash flow or free cash flow, but the multiple is extremely high regardless of which cash flow metric you look at.
46 times cash flow multiples tend not to last long. The U.S. tech stocks are growing, so the multiple could come down because of that. However, these companies’ growth rates are, in many cases, not that high. Also, the growth could reverse, like it did in 2022.
The incredible story of Palantir’s nosebleed valuation
One company that serves to illustrate the priciness of U.S. tech stocks is Palantir. Trading at 200 times adjusted earnings, 354 times reported earnings, and 60 times sales, it is one of the most expensive large cap stocks of all time. The company’s stock got expensive thanks in no small part to an army of retail investors who “pumped” it on X (the social media app formerly known as Twitter). If history is any indication, PLTR will come crashing down like the meme stocks of yesteryear.
Some alternatives to consider
If you’re worried about overvaluation in the U.S. tech sector, you could move your money into non-U.S. stocks or bonds. Non-U.S. stocks are much cheaper than U.S. stocks on average, despite, in many cases, performing as well in fundamental terms.
An exchange-traded fund (ETF) of Canadian stocks would make a lot of sense here. The Canadian markets are more heavily concentrated in value sectors like banking, energy, and utilities compared to the U.S. markets. So, investing in a TSX index fund could be one way to diversify your portfolio away from the 60-times-sales wonders dominating the U.S. markets.
Consider iShares S&P/TSX Capped Composite Index Fund (TSX: XIC), for example. It’s an ETF based on the S&P/TSX Capped Composite Index — the 240 biggest Canadian stocks by market cap. The fund actually holds 220 of the 240 stocks, meaning that it represents its benchmark fairly well.
Why would an investor consider taking a position in a fund like XIC?
First, it’s very diversified, which reduces the risk in its holdings.
Second, its holdings are fairly modestly valued.
Third, its management fee is only 0.05%, so you don’t need to worry about paying most of your return out to the fund managers. It all adds up to a very sensible fund that could diversify your portfolio away from the unbelievably expensive U.S. tech sector.
