Why the tech crash may be far from over

For anyone who makes a living watching the stock market, the recent car crash in tech stocks has been fascinating. There are plenty of reasons to believe it’s not over yet.

That’s not a big deal for Big Tech, though the wealth wiped since the start of the year is enormous. Of these, the five largest tech companies have lost nearly $260 million. The 26% drop was double the drop in the Dow Jones Industrial Average.

There are also some serious problems. Amazon is going through an uncharacteristically severe correction after a massive spending frenzy, and Meta’s problems are all but present as ex-Facebook tries to reposition itself as a metaverse company. But by and large, the premiums of big tech companies relative to the rest of the market have largely disappeared, and the defensive capabilities of these companies could be on display during tough economic times.

Instead, the axe hangs over high-growth tech companies. This is where valuations get the tightest, and where the market has the hardest time finding a bottom. Volatility is likely to remain high as investors look for more appropriate financial metrics to judge these companies, and the right valuation multiples to apply to those metrics.

Income multiples were a favorite among growth investors to chase stocks higher, at least until November’s turnaround. There is plenty of room for further declines on this indicator, especially since markets often overshoot on the way down and up.

Zoom is now trading at less than six times this year’s expected sales, a far cry from the more than 85 times revenue multiples that peaked in 2020. But Redpoint Ventures’ Tomasz Tunguz calculated this week that even after falling nearly 70%, the cloud software company is still trading at a 50% premium to 2017 earnings.

Revenue multipliers are also quickly falling out of favor as investors try to assess the sustainability of companies built for growth but facing financial shocks and a potential recession. As the market boomed, investors and tech executives alike turned away from two of tech investors’ favorite measures of profit — earnings before interest, taxes, depreciation, and amortization; and net income excluding stock-based compensation costs.

Uber CEO Dara Khosrowshahi, tell the staff This week, in a tougher financial environment for the ride-hailing company, it was time to abandon the company’s EBITDA target and achieve positive cash flow. After burning through nearly $18 billion since 2016, he’s fortunate that Uber is already on the verge of hitting that milestone — although it needs a renewed focus on costs to be sustainable on this metric. Many other tech companies are accustomed to having cash readily available in good times, and are a long way from hitting free cash flow milestones.

Meanwhile, issuing restricted stock to employees has become a cash-free way for many companies to find talent in the red-hot tech labor market without hurting Wall Street’s most closely watched earnings metric. Workers are starting to see stock compensation as a guaranteed supplement to their regular income, rather than the options lottery it once was. Dan Loeb as Third Point wrote For his investors this week, it will force companies to either raise cash wages to keep workers happy or issue more stock, which will dilute existing shareholders, but for those still focusing on non-GAAP profit measures. It will be obvious to people.

At the same time, there are many other companies with no profits and few sales methods, making it harder for the market to find a bottom.

Electric truck maker Rivian arrive Despite selling only a handful of cars, its stock market value at its IPO last year was $91 billion. After plunging 80%, Rivian may have found some kind of bottom line: On Wednesday, it was trading at nearly exactly its book value thanks to $15 billion in net cash on its balance sheet. That served as a good basis for Thursday’s 14% rebound after the company reported earnings.

Many companies in a similar position don’t have that kind of balance sheet to rely on.especially so spaceor special purpose financing vehicles to take early stage companies public. Even today’s stressed valuations may appear overly optimistic as risk aversion continues.

richard.waters@ft.com

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