The Great Tech Disconnect

by: Paulo Santos


There seems to be a disconnect brewing in the market.

Tech can do no wrong, others can do no right.

This is happening even as expectations aren't changing, at least not for the better on the favored stocks.

The market view versus the actual stores

At this point, there's something weird happening in the market. Indeed, there are mostly two markets, tech and everything else. This is reminiscent of the dotcom bubble.

While I'm not about to say earnings multiples are some kind of all-knowing metric, I think it's still relevant to highlight the following sample of tech stocks:

  • (NASDAQ:AMZN). Trades at 144x 2017 EPS consensus, 85x 2018 EPS consensus.
  • Netflix (NASDAQ:NFLX). Trades at 155x 2017 EPS consensus, 84x 2018 EPS consensus.
  • Tesla (NASDAQ:TSLA). Doesn't have positive expected EPS for 2017 or 2018.

By itself, these numbers seem rather outrageous. 2018 might seem better, but all of these stocks regularly get their longer-term EPS expectations walked down, so it's likely that and Netflix trade over 100x 2018 EPS as well.

The high multiples are just a curiosity, though. There's something else which is more amazing still. What happened to these three stocks after they recently reported their Q1 2017 earnings? This is what happened:

  • is up 5% since then.
  • Netflix is up 13% since then.
  • Tesla is up 3% since then.

No biggie, then. These are all reasonable movements, you'd say. Yet, what happened to earnings estimates for these stocks after those earnings reports? This happened:

  •'s Q2 EPS consensus fell by 25%. Its 2017 EPS consensus fell by 7%.
  • Netflix's Q2 EPS consensus fell by 38%. Its 2017 EPS consensus fell by 8%.
  • Tesla's Q2 EPS loss consensus increased by more than 400%. Its 2017 EPS loss consensus increased by more than 100%.

What do these stocks share in common, then? Well, they all:

  • Have extremely high valuations from an earnings multiple basis.
  • They all went up after their most recent earnings report.
  • And their earnings reports all led to deep downward revisions both in near-term (quarterly) EPS expectations as well medium-term (yearly) EPS expectations.

You can say the market is more than a little euphoric here, both willing to pay high multiples and disregard large earnings guide-downs.

Now The Disconnect

Let us consider a few companies which aren't technology companies. Instead, they're in a sector nobody loves, retail. Here is our sample:

  • J.C. Penney (NYSE:JCP). Trades at 9x 2017 EPS consensus, 8x 2018 EPS consensus.
  • Macy's (NYSE:M). Trades at 7x 2017 EPS consensus, 8x 2018 EPS consensus.
  • Kohl's (NYSE:KSS). Trades at 10x 2017 EPS consensus, 10x 2018 EPS consensus.
  • Nordstrom (NYSE:JWN). Trades at 14x 2017 EPS consensus, 13x 2018 EPS consensus.

Already we can see a massive difference: All of these equities are at depressed multiples. By and large, the depressed multiples might be warranted due to the online threat.

However, it should also be said that these companies are shifting to online selling as well. Surprisingly, 23% of Nordstrom's revenues are already made online. Arguably, these stores can have some advantages selling online since it's much easier for a customer to try their wares physically, or most importantly for apparel, to return items easily. This is turning into widespread double-digit growth for their online initiatives. This growth is compensating SSS (Same-Store Sales) erosion to the point where J.C. Penney, Kohl's and Nordstrom basically expect around flat SSS for 2017.

The disconnect isn't really just about valuation multiples, though. It's about something else: The earnings reaction to recent earnings reports. Since these retail stocks all reacted to one another's reports, I'll just list how much they fell during the last seven days:

  • J.C. Penney fell 22%.
  • Macy's fell 21%.
  • Kohl's fell 7%.
  • Nordstrom fell 18%.

These are large one-week drops for sure. One would surmise that all of these companies disclosed disasters which greatly changed their economic prospects. Indeed, the reported quarters by and large had something in common:

  • They missed on revenues and SSS, mostly because of a very weak February.
  • They all showed significant improvement in March and April, a part of which might simply have been sales delayed from February to March due to late tax refunds this year.
  • They tended to have in line or better margins, indicating a less-promotional environment.

Of course, you're probably thinking that these companies guided horribly on top of those sales misses. But did they? This is what happened to their earnings expectations for the next quarter and for 2017:

  • J.C. Penney's Q2 EPS loss consensus increased 5%. Its 2017 EPS consensus fell by 2%.
  • Macy's Q2 EPS consensus remained unchanged. Its 2017 EPS consensus fell by 1%.
  • Kohl's Q2 EPS consensus remained unchanged. Its 2017 EPS consensus increased by 1%.
  • Nordstrom's Q2 EPS consensus remained unchanged. Its 2017 EPS consensus remained unchanged.

This is extraordinary. Here you have companies trading at extremely low valuations. They reported earnings which were by and large in line with consensus or above it. More than that, guidance led to no huge drops in consensus for Q2 2017 or for 2017 as a whole. Yet, they all got destroyed by the market.

There might be many reasons to be negative on retail. One of the main reasons is certainly tech competition, mainly tech competition brought by The retailers are adjusting to this competition by increasing online exposure themselves, and arguably while challenged, they are slowly adapting to the environment. This adaptation seems to be leading to overall stabilization, yet the stocks are all being punished heavily on no large change in prospects.


My own take about these developments is that the market is again enamored with technology. Technological companies can do no wrong even when they underperform expectations. Their "victims" can do no good even when expectations are met and guidance does not become worse than before.

This is akin to the environment during the dotcom 1.0 bubble. Back then, technology companies could do no wrong either and were worth any multiple. At the same time, all old economy stocks were to be sold.

If I were to guess, at least 3/4ths of these four retail stocks will outperform the three tech companies indicated over the next year.

Disclosure: I am/we are long JCP, KSS, JWN.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I bought the stocks recently, given the market reaction.