Talking Tech With Mark Mahaney: Three Stocks to Watch

Amanda Heckman: Hello and welcome back to our monthly Tech Roundup. I'm Amanda Heckman, Editorial Director here at Manward. And I'm joined today by Andy Snyder, the founder of all things Manward. Hi, Andy.

Andy Snyder: Hello, good to see you.

Amanda: Thanks for being here. And with us is Wall Street tech veteran Mark Mahaney. Hi, Mark, thanks for joining us.

Mark Mahaney: Hey, Amanda. Hey, Andy.

Amanda: As this is our last video of the year, let's talk about optimism for the tech sector after its very rough year. Mark, I'll start with you. What do you see as the most bullish tech story right now?

Mark: Well, we don't necessarily have to be optimistic. We've had a really challenging year and I think it's one of the worst years we've seen in the tech space in quite some time. Andy, you probably know these numbers off the top of your head, but the Nasdaq is off, what, 32% this year. I think this is one of the weakest, most challenging years we've seen in the tech sector in quite some time. This has got to be one of the top five worst years in the last 30 years or something like that, for a variety of reasons you and I have talked about. I am turning tactically constructive into next year and for three reasons. And remember, I just focus on internet stocks. There a lot of market cap with Google and Meta and Netflix and Amazon, but it's a lot of other names in there too, Airbnb and DoorDash and Spotify, names like that. So it's a broad mix with a lot of small caps in there, but I am turning tactically constructive for three reasons.

I think multiples have been de-risked, estimates have been de-risked and we've seen almost unprecedented level of cost actions taken across tech and especially across the internet sector, i.e., RIFs or reductions in force. And I think that what that means is that as this sector starts feeling cyclical tailwinds at some point on the other side of a probable recession, when the revenue growth starts to stabilize and re-accelerate, it'll do it on a lower cost basis. So you almost create this EPS slingshot opportunity. Those are the three reasons why I'm more tactically constructive. Again, multiples have come down. I look at the major internet companies, I mean 60, 70% of them are at five-year trough multiples on EV [enterprise value] to sales or EV to EBITDA estimates.

Estimates have been cut like approximately 6, 7% each of the last three quarters. Now 6%, 7% by itself isn't much, but you compound it, you do it for three or four quarters and you're talking about 20% to 30% earnings reductions. And both of these points, it's not like multiples can't go down further, that's not like estimates can't go down further, but they have been significantly de-risked. And then, again, the point on the cost cuts, I think it's about 70% of the publicly traded companies that have been around for five plus years, internet companies, they have done RIFs of 10% or 5% at least, and as much as 25%. If you can reduce the cost basis, and we've got this phenomenal or fascinating experiment going on at Twitter now. If Elon Musk can prove that you can cut that employee base by 50% and not materially undermine monetization or profitability, what does that say about the rest of Silicon Valley?

Now, I know there's a lot of different companies in Silicon Valley, but I find it a fascinating experiment. I feel pretty strongly that a good chunk of tech has over-hired, overbuilt for not necessarily bad reasons and not necessarily thoughtless reasons. There was an over extrapolation from COVID, etc. But I think you clearly have an opportunity to take out excess costs, unproductive costs and really get some EPS growth, reacceleration. So that's why I'm more constructive going into next year.

But just to wrap this up, I'm tactically constructive because even looking at the Department of Commerce retail sales numbers yesterday, look, trends are softening. Retail trends, discretionary retail trends are softening. Advertising trends are softening. Travel hasn't yet, but I'm almost certain that it will next year, and in that environment you have to be awfully selective about stocks. The three that I like the most are ones that have sort of a recession-resilient, not proof, but recession-resilient revenue model, have a new revenue stream that's coming online perhaps and/or have taken costs out of their business so that they're set up for these softening trends. And that leads me to Netflix, it leads me to Uber, and in the mid small cap space it leads me to Wix. So those are our top three picks for '23.

Andy: Yeah, I like that. There's a lot to unpack there, but you kind of snuck the idea of growth in there with the mention of a new business model or a new product line coming into the business. I think that's very interesting because we're not hearing a lot of talk about growth right now. We're hearing folks mainly focus on EPS reductions, that sort thing. So I think that kernel of growth right there is pretty interesting to me and shows signs of hope for next year. But you also mentioned the idea of P/Es hitting rock bottom, hitting troughs, and so much of what I've written and talked about is history shows the ideal time to be buying is before that recession. When all this is priced in, we know trouble is coming, we know the slowdowns are in there and we've calculated, pulled all that premium out of there, we know there's opportunity. So this seems to be the time to be buying that at a discount and looking at single digit P/Es.

I recommended a building stock to our VIP subscribers the other day and it's kind of contrary to be recommending a building stock right now when we think the building industry is going to maybe not implode like 2008, but certainly slow down. But I'm not the only one that knows that. That's priced into things, and for that tactile investor that can go out there and look through the numbers, there's definitely value opportunities there. I think that's exciting me, especially in the tech sector because it's been hammered the hardest. So, yeah, I like that.

Mark: Andy, it's a tough one timing these things, and I think there's a little bit of a consensus opinion in the market that the market, it's going to be still challenged in the first half of '23 and then there's kind of this unlock in the back half of '23. And if it's a consensus opinion, then I always ask myself, "Well is it more likely to be too early or too late?" I think the technicians out there are, and people with a lot of history like yourself, are going to say that the market discounts pretty aggressively. Look what we live through with the COVID crisis, just how rapidly the stock market collapsed and how rapidly it corrected well before we knew how bad COVID was going to be and well before we realized we could get out of it.

So the market definitely anticipates, I call those sometimes hope trades and sometimes they're nothing more than hope, but people know that eventually we get back to growth. The longer term investor you are, I sometimes refer to these as Buffett buyers or Buffett buys, then want to step in on the highest quality dislocated assets, what I call DHQ in a book I published. And to me, I can still buy Amazon and Google. They're not one of my top three picks right now. Tactically, for the next three to six months, I think estimates are too high. They're going to have this decelerating revenue growth trends. But those are assets that probably haven't had any structural changes. It's all cyclical pressures, like most all other companies except for the pure defensive ones. I think you can buy those with a long-term outlook.

But when I get back to the tactical longs, to me it's kind of like, if I could show you a company that can actually have accelerating revenue growth next year, that's going to be a huge outlier. When there's no growth, the growth scarcity premium is even higher. I get back to this Netflix. I know the stock traded off yesterday on the news that their ad launch is slower than expected. This is a company that's been a subscription business for 25 years. I think they kind of didn't quite know what they're doing in the first quarter of the gate. I get that. That's growing pains. I still think you've got a really large opportunity ahead of them. They're better addressing their customer base by offering a lower price service.

By the way, in a recession, people are going to want high quality but low price entertainment and you can subscribe to Netflix now for less than the cost of two lattes at your local Starbucks. I think you get more out of your Netflix subscription than you will out of those two lattes. I'm struck by how good of a value to consumers and how good of a value to investors I think Netflix is right here, right now. So it's one of the reasons it's our top long.

Andy: Sure. As we kind of turn for home here, one question sort of unrelated, but I think it's the question is, with tech stocks, specifically internet stocks and the Fed, do you see dislocation there? Jay Powell came out and was kind of pitching his hawkish higher for longer interest rate trend and surprised the market. Do you think that has ramifications? Obviously, there are ramifications for tech, but are they bigger or smaller than a traditional corporate industrial stock?

Mark: No, they're bigger, Andy. So then we're going to have to really stock pick within tech stocks and within internet stocks, because I think we should start off with the working assumption, Andy, that we are higher for longer, in terms of core inflation... and this is more your field than mine, but in terms of core inflation and, therefore, in terms of interest rates for a variety of different reasons. I'll just throw one quick spin by you, which is we seem to be in a process now of reversing what has been decades of globalization, i.e., we're going to be unlevering, de-levering from China, for a variety of reasons. That's a pretty material change and you're changing supply chains. There's a reason that you walk into a Walmart and everything you see in there is made in China Just about everything you see in there is made in China, because it's cheap, it's fast, it's super efficient and convenient.

So we're going to be rebuilding that in a couple of different markets. That means you're going to have inefficiencies at first and that means prices are going to be higher. And I'm not talking about for a quarter or two, I'm talking about this could be a, well be a multi-year, maybe even a decade plus trend. That's just one simple factor. But globalization over the last three decades has meant disinflation or deflation and now I think we're reversing it. So that's a long-winded answer. If inflation is higher, interest rates are higher, that means long-duration assets are going to have a much tougher time in the next 1, 2, 5 years, even 10 years than they had the last 1, 2, 5, 10 years. So when you go to tech, you should be looking for the highest quality names where you want some positive free cash flow.

You want to be able to talk about gap earnings, P/E multiples. You can do that with Netflix and I think you're just going to start doing that with Uber. They just hit this free cash flow inflection point. You're on your path to a, I think a 7, 8% free cash flow yield on 24 numbers. I think Amazon can work. I think Google can work. I think those high flyers, 10 to 20 times price to sales stocks, they work for a period of time, but that period is not here and I don't think it's going to return. I'm sure it will someday. I never seen ever, but I think that could be a couple of years. So you're going to have to be awfully selective within tech.

Andy: Yeah, I think summarize that, we're in the midst of a sea change, and within that sea change, a pretty big macro sea change. It's a stock picker's market. I said the other day, it's not a great time to go out and just buy an ETF and ride it out You'll never optimize your portfolio that way. In 2023, this is definitely year we want to be tactile and go in there and look for the right things. So very good, that's exactly why we've brought you on board and we're happy to have these conversations every month. So, Amanda, I'll hand it off for you to take us home.

Amanda: I’ll bring it home. That's a great spot to leave it. Thank you for the optimism and things to look forward to for sure. Thank you to everyone who has watched and thank you, Andy and Mark, for a great conversation. And we'll be back in January with more tech insights. Until then, we want to wish everyone a very Merry Christmas, Happy Holidays, Happy New Year. We'll see you next year.

Andy: Very good, thank you.

Mark: Merry Christmas, Happy Holidays.