Despite the pandemic, the stock market was rallying to unprecedented levels on the back of the tech stock uptrend. However, the market corrected as bears have overpowered bulls over the last two months. The S&P 500 Index has fallen 8.7% since September 2nd after rallying 60% since March 23rd. The Nasdaq Composite Index corrected 9.5% after rallying 75.7% during the same period.
The pandemic-driven lockdown created a wave of digitization, including cloud computing, work-from-home, and e-commerce. This wave sent tech stocks to sky-high valuations as their businesses prospered, while other businesses like oil and gas and airlines suffered.
The tech-driven rally made tech stocks account for nearly 40% of the S&P 500 Index valuation, with the $2 trillion market valuation of Apple (AAPL) accounting for 7% of the index. Market pundits are divided over this tech rally. Some believe that the tech stocks are overvalued and have formed a bubble, similar to the dot.com bubble in 2000, which could burst at any time. Others believe that this tech rally is backed by fundamentals and is here to stay.
Then what led to the market pullback. Was it the gravity of fundamentals or the gravity of market conditions?
The market pullback
A lot happened in the U.S. stock market last month. Investors were getting impatient due to a stalled second fiscal stimulus package and the uncertainty around the US presidential election. The future of the tech sector and the US-China trade-tussle will depend on who wins the White House.
The election uncertainty has been exacerbated by a resurgence of COVID-19 cases in the United States, Europe, and Canada. On top of that, mixed third-quarter earnings by tech companies created a market pullback, even when overall results reported by the S&P 500 companies so far, show a decent improvement.
The fourth quarter is generally the time for a tech stock rally as investors price in holiday season sales. But high valuations of tech stocks show that investors have already priced in inflated earnings expectations. Now, the second wave of the pandemic and elections are making them doubtful.
The stock market pullback over the past two months has created an opportunity to buy fundamentally strong stocks like Broadcom Inc. (AVGO), Adobe Inc. (ADBE), and EPAM Systems, Inc. (EPAM) at discounted prices. Both technical and fundamental indicators show bullish sentiment for these three stocks toward the year-end.
Broadcom Inc. (AVGO)
AVGO is Apple’s largest component supplier. In my previous article on the iPhone 12 super cycle, I was bullish on the stock because of large order volumes expected from Apple. Moreover, AVGO’s broad range of connectivity chips and end-to-end 5G solutions make it a key beneficiary of the 5G revolution.
There is no change in these two growth drivers. Short-term traders got a little skeptical around recent events that spelled a bearish tone for the chipmaker. Firstly, Apple’s recent earnings reported a more than 20% year-over-year decline in iPhone revenue because of the late launch of iPhone 12. But this doesn’t mean iPhone 12 revenue would not increase towards the end of the year.
Secondly, AVGO CEO Hock E Tan sold around $50 million worth of AVGO shares last month. This could be a regular trade. Lastly, the European Commission ruled that AVGO will suspend its existing exclusivity or quasi-exclusivity arrangements on chips used in TV set-top boxes and internet modems. These exclusivity deals helped AVGO keep competitors at bay and gain market share.
But the bigger picture of 5G and enterprise software is the real deal. Even though AVGO is trading at 6.7 times its sales per share, it is justified by its last five years revenue CAGR of 30.5% coming from acquisitions. AVGO expects its fourth-quarter revenue to rise 10.8% year-over-year to $6.4 billion.
The short-term headwinds and market pullback caused a 6% price decline of AVGO stock from its September high, dragging it below its 50-day moving average. The stock is closer to being oversold, with a Relative Strength Index (RSI) of 39. AVGO could even fall to its 100-day MA of $338.74, before returning to an uptrend. Its current price represents a 15% discount from its average price target of $402.
How does AVGO stack up for the POWR Ratings?
A for Trade Grade
B for Buy & Hold Grade
A for Industry Rank
B for Peer Grade
B for overall POWR Rating
The stock is also ranked #21 in the 86-stock Semiconductor & Wireless Chip industry.
Adobe Inc. (ADBE)
Another fundamentally strong tech stock is ADBE, which fell 12.4% from its September high. The company has everything going right for it. The pandemic-triggered digitization is increasing the demand for its creative cloud and document productivity solutions.
Its fiscal 2020 third-quarter earnings were the best in its history, with revenue and EPS increasing 14% and 22% year-over-year, respectively. The stock surged 87% from its March low on the back of this new pandemic-induced digitization trend. But the market correction pulled down ADBE stock below its 100-day MA.
Technical indicators show that ADBE stock is forming a double bottom pattern, which looks like the letter W. The first dip is around 10%-20%, and the second dip is 3%-4% from its previous low. ADBE stock is currently oversold with an RSI of 34. The stock could fall further and hit bottom. When a fundamentally strong stock bottoms, it offers a significant upside.
The second wave of the pandemic ensures that ADBE is on track for another record of revenue growth of 12% year-over-year in the fourth quarter. This justifies its 18x price-to-sales (PS) ratio. The strong fundamentals could attract the bulls to buy the stock at a 3% discount from its average price target of $461.1.
ADBE has a grade of “B” in Industry Rank in our POWR Ratings system. In the 96-stock Software – Application industry, it is ranked #12.
EPAM Systems, Inc. (EPAM)
EPAM is a fast-growing IT and enterprise software solutions company that caters to different sectors from business information to financial services. The company was growing rapidly between 2016 and 2019, with a revenue and EPS CAGR of over 20% and 30%, respectively. In fact, its stock surged more than 80% last year.
The pandemic accelerated the move to digitization across the globe. While EPAM benefitted from demand uptick in other sectors, it saw a decline in travel and airlines. In the second quarter, its revenue and EPS surged 15.5% and 14.1% year-over-year, respectively. This impressive financial performance drove EPAM’s stock more than 100% from its April low. After a correction in September, the stock made a new high in October.
But the stock is currently trading close to its 100-day MA of $299.24 because of the recent market pullback. The stock is down 12% from its October high, ahead of its third-quarter earnings on November 4th. The stock is oversold with an RSI of 35. This is the first time since March the stock is oversold.
EPAM stock could return to its rally if the company meets its third-quarter revenue guidance of a 8.5% year-over-year increase. This growth justifies its 7.8x PS ratio. This is a good time to buy the stock while it trades at a 5.5% discount from its average price target of $322.8
EPAM is rated a “Buy” in the POWR Ratings. It holds “B” in Trade Grade, Buy & Hold Grade, Peer Grade, and Industry Rank. It is also the #18 ranked stock in the Software – Application industry.
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AVGO shares were trading at $348.84 per share on Monday afternoon, down $0.79 (-0.23%). Year-to-date, AVGO has gained 14.45%, versus a 3.25% rise in the benchmark S&P 500 index during the same period.
About the Author: Puja Tayal
Puja is a seasoned writer working with financial publishing companies like Motley Fool Canada and Market Realist. With over 13 years of experience in the field of fundamental research, she brings a blend of comprehensive, well-researched insights into her articles. More...
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