Tech Stocks Will Disappoint You

Tech stocks have been soaring in 2020. Even after stumbling in September, they’re still up massively for the year. Amazingly, they’ve managed to keep up the momentum despite a pandemic that has ravaged most industries. For proof, just look at the returns the FAANG stocks achieved in 2020:

  • Facebook (FB): up 50% in 2020
  • Amazon (AMZN): up 99% in 2020
  • Apple (AAPL): up 107% in 2020
  • Netflix (NFLX): up 96% in 2020
  • Alphabet (GOOG) (NASDAQ:GOOGL): up 29% in 2020

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There’s no denying that these are impressive results. Some tech stocks are approaching 200% returns in 2020, and the year isn’t even over.

If you’ve watched all this unfold, it’s natural to ask yourself whether you should increase your portfolio allocation in tech stocks. Especially if you invested in COVID-19 sensitive industries like airlines (JETS) and energy (XLE), it’s hard not to look at tech investors with envy.

But before you rush into tech stocks, a word of caution is in order. Tech stocks actually aren’t guaranteed to outperform. In fact, over certain timeframes, they’ve underperformed the broader market. With valuations reaching sky-high levels, the possibility of another 2000-style bubble is very real. And as you’re about to see, there are better assets to invest in today.

Tech Doesn’t Always Outperform

Before digging into the data on why tech could disappoint in the future, I need to dispel a major misconception about tech’s past returns:

The notion that “tech always wins.”

That’s demonstrably not true.

While tech stocks have been doing well in recent years, you’d actually have underperformed if you bought them in 1999. Everybody knows that the late 90s tech bubble burst around 2000. What most don’t know is that the crash was so severe it dragged tech stocks’ annualized return down over a 20-year period. As proof, check out the chart below.

As you can see, the Nasdaq underperformed the S&P 500 (SPY) from February 1999 to February 2020. On the other hand, REITs outperformed the S&P 500 by nearly 2-1. So clearly, tech stocks don’t always outperform. If you buy in the middle of a tech bubble your 20-year return could end up lagging the broader market. Meanwhile, “boring” income investments like REITs could serve you well.

Valuation: The Thorn in Tech Investors’ Side

A big problem with tech stocks in 2020 is that some of them have extremely steep valuations. That is, they’re very expensive compared to the claim on underlying earnings and assets. This isn’t quite 2000, with overvaluation across the board, but many tech stocks are getting pricey.

Consider Amazon (AMZN). As of right now, it has a P/E Ratio of ~130. That means that the stock is trading at more than 120 times the past 12 months’ earnings. It would take a lot of sustained earnings growth for the company to actually be worth that much. Companies can trade at steep valuations for a long time before they come crashing down. But Amazon’s current valuation is steeper than it has been in recent memory:

The same goes for top tech stocks like Tesla (TSLA) and Shopify (SHOP).

Basically, we’ve got a lot of tech stocks these days trading at bubble valuations. Tech as a sector has been here before. But this time, it might not be able to recover.

Big Tech: Future Growth Unlikely to Resemble the Past

A big problem when it comes to tech’s future growth is market saturation. A lot of the big tech companies’ core offerings have reached close to their total accessible market. Everybody uses social media. Everybody has a smartphone. Everybody who’s interested has a Netflix (NFLX) account. That naturally puts a damper on growth potential.

A tech bull might say, “well, they could raise prices, acquire competitors or launch new services.” But success in those ventures isn’t guaranteed. Acquisitions can flop, new products can fail to take off, and price increases won’t necessarily be accepted by customers. Moreover, increasingly many are calling for big tech to be broken up. If you type “big tech” on google, the top news are commonly about them being targeted for antitrust issues, higher taxation, and stricter regulations:

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Finally, even if growth efforts do pay off, they won’t deliver the kinds of returns tech achieved in the past. A $100 million IPO going to $1 billion would turn a $10,000 investment into $100,000. But if a $2 trillion company rolls out a new service that sells $1 billion a year, that might not impact its stock price much at all.

When a company is worth trillions of dollars, it gets hard to scale rapidly. Yet tech stocks are priced as though their strong growth will continue forever. That’s unlikely to happen. Like Warren Buffett says, “size is the anchor of performance.”

FAANG Stocks are Outliers

There’s still one way to get big returns in tech.

That is by picking small caps that are likely to become the “FAANG” stocks of tomorrow. The problem is that doing this is very difficult. Today’s big tech giants originated from a much larger pool of startups. Many of them went belly up in the original dotcom bubble. The trillion-dollar giants you see today are just a few outliers in an industry that has seen countless failures.

Outliers are unlikely to occur by definition. An outlier is something that’s not typical of the set it’s a part of. If you try to pick the “next” big tech winner, you’re likely to end up picking several losers. That’s just the cold, hard statistical reality.

Where to Invest Your Money Instead of Tech

So, if tech stocks are unlikely to continue rising as they have this year, where do you put your money? After all, aren’t traditional industries getting hammered by COVID-19?

First of all, not all traditional industries got beaten down by COVID-19. Discount retailers have done well. As have alcohol companies. Just take a look at the strong performance of Dollar General (DG) as an example:

ChartData by YCharts

But we are not suggesting that you invest in retailers or alcohol companies. Out of all market sectors, we believe that now is a great time to put your money in real assets. That is, in assets that have a real, physical presence in the world. These include:

  • Apartment buildings.
  • Storage facilities.
  • Warehouses.
  • Railroads.
  • Or even net-leased Dollar General Properties:

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These types of assets offer great income potential and tremendous upside in today’s market, particularly real estate in the form of REITs.

REITs, as measured by the Vanguard Real Estate Index Fund (VNQ) are currently down 16% on average, and many individual names are down by up to 30%, 40%, or even 50%.

As a result of having fallen this year, the REIT space has plenty of bargains available. REITs are currently priced as if they’re in for a continued beating. The COVID-19 crisis has certainly spooked the market. But not all REITs are actually being negatively impacted by the pandemic.

Take AvalonBay Communities (AVB), for example. All through the COVID-19 crisis, it has managed to achieve collection rates close to 100%. In September, for example, it had a 95% collection rate. That’s not unusual either. According to NAREIT, the average collection rate for industrial, office, and apartment REITs is more than 95%. Even free-standing retail REITs are above 90%.

Put simply, all the hype about rent collection issues isn’t being reflected in REIT collection rates. Yet the market continues to price REITs as if they’re in danger.

As a result, you’ve got REIT valuations at a near 10-year low despite solid fundamentals. AvalonBay owns defensive rental properties, it has an A-rated balance sheet, and yet, it’s down by 30%. It pays a steady 4.2% dividend yield, and it has 50% upside potential just to return to fair value. This is the kind of situation that tends to pay off for prudent investors.

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REITs aren’t going anywhere. People always will need places to live, goods always will need places to be stored, and businesses always will need places to operate. REITs are there to cater to these universal necessities. And in 2020, they’re performing very well—as businesses—while being punished by the market. A solid opportunity to buy into a lucrative asset class at discounted prices.

Historic Market Opportunity! 

The recent market crash has created exceptional opportunities. Many high-quality REITs are now offered at >8% sustainable dividend yields and have 100-200% upside potential in a recovery.

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Disclosure: I am/we are long AVB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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