Not A Bubble! Julian Lin On Tech's Profitability, Reasonable Valuations

JL: I think with tech stocks being up by a wide margin this year, I'm seeing a lot of investors starting to call them another bubble saying it's just the tech bubble all over again. But I think there's some important nuances here. I mean, just -- and it goes beyond the fact that tech stocks are not at all-time highs. I mean, obviously Microsoft (MSFT) is still up, is making new highs, but the typical tech stock is still down a lot since their all-time highs.

But the big difference is between now and before, just besides the recovery would be two points, one is profitability and the second one is the valuation reset. And in terms of profitability, we've seen a lot of these companies deliver rather dramatic transitions and margins that might be something like going from non-GAAP profitability to GAAP profitability.

Tech is one of the strongest secular growth stories in the market. There was a reason why tech stocks became a bubble during the pandemic, even if the actual valuations were not justified.

And as I detailed in a past public article on Palantir, I believe that they will eventually have what I call an NVIDIA moment. Meaning just there will be a moment where the company shows in the fundamental results that the demand has arrived, that customers are coming, and they're trying to very aggressively deploy more generative AI applications. But the interesting point with Palantir is that, none of this has arrived yet.

JL: Yes, absolutely. I think, well, they obviously deserve credit for making that transition to GAAP profitability. But at my core, I still care deeply about valuation. If revenue growth is, continues trending downwards and gets to like 12%, 10%, 9%. The current valuation does not quite make sense. Just – it doesn't – it will be a little bit too rich.

RS: Any thoughts on your other tech favorites?

JL: Yes, I think that it might be difficult to name a compelling small medium cap name just given that valuations are just so much more rich relative to 12 months ago. 12 months ago, you could have just thrown a dart at a board and you could have come up with a pretty attractive thesis for almost any name. But right now I think overall the tech sector will perform strongly, but the average tech stock and they're kind of more fairly valued.

I think my top picks in the tech sector are still going to be some of those mega cap names. I like both Meta Platforms (NASDAQ:META) and Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) for similar, but also different reasons. It's interesting that Meta Platforms is now trading at a premium to Alphabet, whereas it typically had traded at a discount, a lot of that is due to the fact that Meta Platforms has been executing very strongly.

They delivered an incredible year of efficiency. This year, for example, their Family of Apps profit margins is over 50%, which is quite stunning. Obviously their overall margins is being pulled back due to their ongoing investments in the metaverse, but even then their profit margin is still very high overall. And Meta Platforms have shown that they are a huge artificial intelligence beneficiary.

As a customer of their own artificial intelligence, they have been able to overcome the competition threats from TikTok, overcome the data privacy changes from iOS largely due to AI. And I personally use a lot of their products, Facebook and Instagram. I have noticed how they have been able to recommend posts that I don't follow.

That’s all AI. It's quite incredible how strongly they've executed at Meta Platforms, and the stock is still trading at compelling valuations, especially if you back out on the Reality Labs’ losses just to try to get a better sense of what you're paying for that, Instagram and Facebook.

On the other hand, Alphabet, Alphabet is trading a bit lower just largely due to the perception that it is losing market share in search with being having that ChatGPT first mover advantage. And Google's Bard maybe being still subpar at this point. So, there's a couple of things with Google.

One obviously valuation. This is a name that's trading quite cheaply. And that's even before accounting for its large other bets losses. But I think people are underestimating the high moats at Google. But more importantly, what I don't see being talked about much is the fact that Google has not done the same aggressive cost cutting, seen at something like Meta Platforms, or other tech names.

If I recall they only laid off around 3% of the workforce, which relative to maybe the 30% layoffs at Meta Platforms indicates that if Google were inclined they could always have that lever up their sleeves to even to make -- to further increase their earnings and then the stock will be even more cheap. So, I think that there are some in spite of the -- perhaps relative bearishness on the name due to the competitive threats on being and the ongoing lawsuits, the DOJ and it's payments to Apple (AAPL). There's a lot of reasons like Alphabet over the next, over a five year time horizon.

RS: What are your thoughts on NVIDIA (NVDA)? Just because it's such a kind of oft-mentioned name when we're talking about tech and AI and especially when we're talking about AI mania and whether or not there's a bubble that's definitely the stock that people point to, if I’m just curious your thoughts there?

JL: Yes, NVIDIA. Yeah, this is a good one. So, I think, I was previously a big skeptic. It was very embarrassing. I was a skeptic of NVIDIA before, this big generative AI moment then after the stock went up a lot because of generative AI, I was a bigger skeptic. I doubled down. But as I noted in my last publicly published article on NVIDIA, I was clearly wrong. So, what's happening at NVIDIA is quite interesting.

Sure, the valuation has soared incredibly, but I'm viewing this moment as being very similar to what happened when Apple overtook BlackBerry. And BlackBerry previously to Apple releasing the iPhone, BlackBerry was the dominant smartphone provider.

Obviously, that's not quite the same with NVIDIA and (AMD). They were kind of more of a duopoly, but with BlackBerry after the iPhone came out, you know, BlackBerry just could not compete. They were just on a different competitive playing field to the iPhone and to Apple. So, I'm viewing that to be the case with NVIDIA.

I think this is explaining why NVIDIA is trading is such high valuations, mainly because now it is being viewed as having this kind of barriers to entry similar to Apple, right? You find Apple trading at around 28x earnings in spite of very modest growth. That is because of the perception of having such a high quality business.