Technology Stocks In Our Portfolio

I want to get today's post out as quick as I can because I have been receiving a lot of the same questions from current subscribers regarding the technology sector of our portfolio. Per my previous posts in the educational series, particularly about higher interest rates and how that can affect stock market, I wrote that investors should avoid high-growth, high-multiple, concept technology stocks. However, the portfolio has a "Technology" sector which we currently owns Apple (AAPL), Microsoft (MSFT), Salesforce (MSFT), Meta Platforms (FB), Cisco (CSCO), and you may include Advanced Micro Devices (AMD) as well. These stocks trade at earnings multiples north of 20 times forward. Why say one thing, and still do it anyways? What's the difference between the high multiple growth stocks that the portfolio currently owns, versus the stocks that I said to stay away?

Portfolio Structuring - Diversification

First, the presence of technology/ growth sector in our portfolio serves a diversification purpose. We cannot just own industrial/ cyclical stocks 100%, so we want to have a barbell approach, diversifying with some technology/ growth stocks. 

Second, it's not entirely true that you should stray away from ALL technology/ growth stocks. Actually, you do want to have some in this sector. This is because raising interest rates potentially slows down the economy, and when that happens, industrial/ cyclical stocks will undoubtedly take a hit. What's special about growth/ technology is that they are secular by nature, meaning they are not very economically sensitive. A Ford (F) will sell less cars in a downturn economy because people can't afford new $40,000 cars, yet a Microsoft (MSFT) will not be too concerned because demands for computers, office products and most importantly, product subscription will remain relatively strong. When the economy slows down, decrease in loan activities will hurt Wells Fargo (WFC), but will not hurt Apple (AAPL) as much because people aren't going to go back landlines. You see, companies like Apple and Microsoft are well positioned in a secular digitization theme, one that will not revert backwards on the heels of economic cyclicality. You can almost call Apple a consumer staples company just like Colgate, because who doesn't need cell phones to function these days?

So we actually want to own some of these companies for the other side of the economic downturn. But these can still work when the economy is booming. That's why they're called secular.

Reasonable Multiples

The problem really comes down to picking the right stocks. Tightening of monetary policy makes the cost of money more expensive, and discounting the future value of a company further. As a result, companies trading at high multiples will effectively become less valuable/ less attractive. We want to own companies with reasonable multiples. What does that mean? It is relative, but here are some key metrics. First, you always want to compare to the forward multiple of the S&P500; this can be found with a simple Google search; currently, that multiple is about 21.3 of December 2022 earnings. Second, to make a more apple-to-apple comparison, you want to compare to the forward multiple of companies in the same sector. Here's when you have to put an investor hat on: if the multiple is smaller, do you see opportunity in there (because there is a change story ongoing and that should help improve the multiple). On the other hand, if the multiple is higher, can you justify owning at such high multiple.

Portfolio Action: Cutting Salesforce (CRM)

Just directly applying what we said here, our portfolio today is cutting shares of Salesforce (CRM). We owned a position that was 4.7% of our portfolio, and we're cutting that to 1.2% now. Three reasons. First, even though CRM is the best in the business, it has a rather very high multiple, trading at ~52x forward earnings. That is twice as much as the SP500, much higher than Microsoft's multiple of 30. Second, because of this high multiple, there has been a de-rating process going on in this stock, as it has been off nearly 20% from its 52-week high. Third, the de-rating process seems to be continuing, because shares have recently lost a key support, the 200-day Moving Average.

This is a prime example of our portfolio coupling fundamental analysis with technical analysis. We've made the mistake twice before in Disney and Paypal, not minding the 200-day Moving Average, but here we have the opportunity to not repeat that mistake again. Our big cut of this position is a loss-cutting move, realizing a 11% loss in our 4% portfolio weight position.

Do we still believe in Salesforce as a company? Absolutely. They're best of breed in what they do. However, what we're participating in is a market, and at the moment, we believe that market participants are not finding the valuation of Salesforce attractive. 

What are we going to do? We're going to wait for this de-rating process to unwind, and slowly scale in our position when conditions are met. We'll telegraph the move with you in the future.

What do we use the cash for? We're going to use the cash to increase our allocation to Morgan Stanley (MS), so we're no longer overweight in that position. Remember yesterday, we bought shares of MS and we said we'd be 1% greater than our 8% allocation. However, with the trim of Salesforce today from 4% to 1%, we're going to make MS weigh 10% of our portfolio. You can always check details here.