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Reasons why the tech stock crash may be far from over 

 May 3, 2022

For anyone who watches the stock market for a living, the recent car crash in tech stocks was intriguing. There are many reasons to believe it’s not over yet.

For Big Tech, this isn’t as much of an issue, although the wealth wiped out since the beginning of the year is significant. Combined, the top five tech companies lost nearly $2.6 trillion. That’s a 26 percent drop, double the Dow Jones Industrial Average.

There are still some serious questions. Amazon is suffering an unusually severe adjustment after a massive spending spree, while the problems Meta faces as the former Facebook seeks to reposition itself as a Metaverse company are little less than existential. But in general, Big Tech’s premium to the rest of the market has largely disappeared and the companies’ defensive qualities should show up in tougher economic times.

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Rather, the ax hangs over high-growth tech companies. This is where valuations have widened the most and the market is having the most trouble finding its bottom. As investors look for more appropriate financial metrics to evaluate these companies, as well as the right valuation multiples to apply to these metrics, volatility is likely to remain elevated.

Multiples of earnings was a favorite that growth investors used to chase stocks higher, at least until the turn that began last November. At this metric, there is ample room for further declines, especially since markets often overshoot both on the way down and on the way up.

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Zoom now trades at less than six times this year’s expected sales, a far cry from the more than 85 sales multiple it achieved in 2020. But Redpoint Ventures’ Tomasz Tunguz calculated this week that even after falling nearly 70 percent, cloud software companies are still trading at a 50 percent premium to 2017’s price-to-sales ratio.

Sales multiples are also quickly falling out of favor as investors seek to assess the sustainability of companies poised for growth but experiencing financial shock and a potential economic downturn. Both investors and tech executives are beginning to steer clear of two popular earnings metrics that took hold among tech investors when the market was booming — earnings before interest, taxes, depreciation and amortization; and net earnings excluding stock compensation costs.

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Dara Khosrowshahi, CEO of Uber, staff said at the ridesharing company this week that in a tougher financial climate it was time to drop the company’s ebitda targets and move to positive cash flow. Having burned nearly $18 billion since 2016, Uber was fortunate that Uber was already close to hitting that milestone — though it will need a renewed focus on costs to become sustainably profitable at this measure . Many other tech companies, accustomed to the quick supply of cash in good times, are still a long way from reaching the free cash flow milestone.

Issuing restricted stock to employees has now become a cashless way for many companies to find talent in a red-hot tech job market without hurting the earnings metrics that Wall Street has paid most attention to. Workers now view stock compensation as a guaranteed supplement to their regular income rather than an option lottery. As Dan Loeb from Third Point wrote to its investors this week that will force companies to either increase cash payments to keep employees happy or issue a lot more stock, something that will dilute existing shareholders but wouldn’t be obvious to anyone who cares still dealing with non-GAAP earnings measures.

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Meanwhile, there are many other companies that are not making any profits and are making very little sales, making it all the more difficult for the market to find a bottom.

Electric truck manufacturer Rivian reached had a stock market value of $91 billion at the time of its IPO last year, despite only selling a handful of vehicles. After collapsing 80 percent, Rivian may have found some kind of bottom: As of Wednesday, it was trading almost exactly at book value thanks to $15 billion in net cash on its balance sheet. That proved a good basis for a 14 percent gain on Thursday after the company reported earnings.

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Many companies in a similar position do not have such a balance sheet to fall back on. This is especially true for the spaces, or special purpose funding vehicles used to take early-stage companies public. As risk flight continues, even today’s stressed valuations may appear overly optimistic.

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