Reasons why the tech stock crash is far from over

For anyone who watches the stock market for a living, the recent crash in tech stocks has been astounding. There are plenty of reasons to think it’s not over yet.

That’s not a big deal for the big tech companies, although the wealth wiped out since the start of the year is significant. Between them, the five largest technology companies lost nearly $2.6 trillion. That’s a 26 percent drop, which is double the drop in the Dow Jones Industrial Average.

There are still some serious questions. Amazon is experiencing an uncharacteristically sharp adjustment after a massive spending spree, while issues facing Meta like the ex-Facebook are trying to re-position itself as a sparsely-existing metaverse. But overall, Big Tech’s premium to the rest of the market has been largely erased and the defensive qualities of companies are likely to emerge in tough economic times.

Instead, the ax is hanging in front of high-growth technology companies. This is where the valuations are getting more exhausted, and where the market is having a hard time finding its lowest level. As investors look to more favorable financial criteria to judge these companies, as well as the correct valuation multiples to apply to those metrics, volatility is likely to remain high.

Revenue multiples were the favorites that growth investors used to chase stocks higher, at least until the turnaround last November. Based on this metric, there is plenty of room for further declines, especially as markets often overshoot on their way down as well as on their way up.

Zoom is now trading at less than six times sales forecast for this year, a far cry from the over-85 revenue multiplier that peaked in 2020. But Thomas Tongoz of Redpoint Ventures calculated this week that even after a nearly 70 percent drop, no Cloud software companies are still trading at a 50 percent premium to the price-to-revenue multiples of 2017.

Revenue doubling is also falling rapidly as investors try to assess the sustainability of companies that are built for growth but face a financial shock and potential economic downturn. Both tech investors and executives are starting to move away from two favored measures of profit that tech investors have captured as the market booms—earnings before interest, taxes, depreciation, and amortization; and net profit which excludes stock compensation costs.

Dara Khosrowshahi, Uber’s chief executive, told employees at the taxi company this week that in a tougher financial climate, it was time to abandon the company’s interest, tax and depreciation targets to become cash-flow positive. Having exhausted nearly $18 billion since 2016, he’s fortunate that Uber was already on the cusp of that milestone — although it would take a new focus on costs to become sustainably profitable in the measure. Many other tech companies, accustomed to a supply of ready cash in the good times, still have a long way to go to reach the free cash flow stage.

Meanwhile, distributing restricted stock to employees has become a cash-free way for many companies to find talent in the fiery tech job market without hurting earnings metrics that Wall Street has paid so much attention to. Workers have come to view stock compensation as a guaranteed supplement to their regular income, rather than an options lottery as it once was. As Third Point’s Dan Loeb wrote to his investors this week it would force companies to either raise cash wages to keep workers happy or issue more stock, something that would weaken existing shareholders but wouldn’t be obvious to anyone still looking for non- GAAP Standards for Earnings.

Meanwhile, there are many other companies that have no earnings by any measure and very few in terms of sales, which makes it difficult for the market to find a bottom.

Electric truck maker Rivian reached a stock market value of $91 billion at the time of its initial public offering last year despite it having sold only a handful of vehicles. After dropping 80 percent, Rivian may have found ground of sorts: On Wednesday, it was trading at nearly book value, thanks to the $15 billion net cash on its balance sheet. This turned out to be a good basis for a 14 percent rebound on Thursday, after the company reported earnings.

Many companies in a similar situation do not have this type of balance sheet to reference. This is especially true of Spacs, or special purpose financing vehicles, that have been used to bring early-stage businesses to the public. With the continued flight from risk, even today’s pressurized valuations may look overly optimistic.

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