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AI stole the tech investment spotlight in 2023. As investors enter 2024, maybe they’re asking if the rise of AI stocks was too much, too soon?
Seeking Alpha analyst and Investing Group leader Julian Lin says some AI-specific stocks are certainly overvalued heading into the new year. Generative AI, however, could deliver an unanticipated opportunity for some looking in the right places.
Looking deeper, Lin suggests large-cap tech will continue to deliver steady returns. He makes the case for value over growth for 2024. The analyst also looks at undercovered opportunities in the cannabis sector in this Q&A:
Seeking Alpha: It was an interesting year for tech stocks, especially for companies tied to AI. Has the tech opportunity played out for investors, or do you still see areas of opportunity in 2024?
Julian Lin: I entered 2023 with the view that tech stocks were one of those rare asymmetric opportunities that investors can only dream of. Valuations were too pessimistic and were pricing in the end of growth, but many tech companies had net cash balance sheets and secular growth engines. Twelve months later, and the narrative has flipped. The rise of generative AI has helped tech stocks soar once again to lofty valuations, but the rally at least directionally is much deserved. Tech companies showed an unusual ability to drive substantial margin expansion in the face of a tough macro environment, and for that reason do deserve higher valuations, but it remains to be seen if this is “too much.”
SA: Software is an area that you extensively cover. And there has been a great deal of attention on the developments with AI and its impact on the industry. Do you think AI as a whole is becoming too frothy, or are there still other areas (such as software) where investors can invest with confidence?”
JL: Wall Street is notorious for being forward-looking, and that has proven all too true this year, with names like Nvidia (NVDA) quickly pricing in the incredible results it has shown as of late. It’s unclear if AI or the prospects of interest rate cuts are to blame, but many names with some AI connections have been flying to suspicious levels. But even in my coverage of more obvious AI names like NVDA or Synopsys (SNPS), I am of the view that there’s not a lot of meat left on the bone. That said, generative AI is likely to benefit all sectors of the market especially beyond the tech sectors through increasing operational efficiencies. Chances are, you are investing in generative AI whether you know it or not.
SA: A lot of focus has been on the “Magnificent 7” tech stocks. Is it time to move on from these names, or does large-cap tech still present a “steady as she goes” investment?
JL: I am of the view that the broader S&P 500 market index (NYSEARCA:IVV) may still deliver 8% to 10% forward annual returns, so that opinion does imply that in general I have a favorable view of the Magnificent 7. In spite of strong performances over the past year, Wall Street still is not fully appreciating the strong balance sheets and operating leverage potential of names like Meta Platforms (META), Alphabet (GOOG) (GOOGL), and Amazon (AMZN). META and GOOGL trade at below-market multiples in spite of having high quality business models, net cash balance sheets, and above-market growth for years to come.
SA: Is it time for a bigger focus on value over growth?
JL: One year ago, my answer would have been a resounding no. Now, I tend to agree that value stocks look more compelling than growth stocks. One must be careful to avoid highly leveraged names as they will see significant headwinds from the higher interest rate environment. In general, I’m focusing on names that have strong balance sheets while also offering enough value amidst a higher interest rate environment. The higher interest rate environment means that we must be mindful of potential headwinds from debt refinancing as well as the fact that opportunity cost is much higher across the board. Not all dividend stocks look cheap, but you don’t have to look that hard to find bargains.
SA: Cannabis is another area that you cover. What parts of this industry should investors avoid? Are there opportunities in certain cannabis sectors?
JL: There has been renewed interest in the cannabis sector due to prospects of legislative reform – specifically market participants appear optimistic that the DEA will re-schedule cannabis to Schedule III as recommended by the HHS. That action would address 280e taxes, which would help to boost free cash flow by 50% or more for many cannabis operators. On the flip side, these operators are burdened with significant debt loads and price compression continues to pressure profit margins. The stocks of multi-state operators (MSOs) trade at around 5x to 10x adjusted EBITDA, but it’s not clear if they are deserving of higher multiples given the road bumps to the growth story. I continue to favor a few cannabis REITs due to free cash flow generation, strong balance sheets, and attractive dividend yield. Cannabis REITs might not generate as much hype as MSO stocks, but stand to benefit from federal reform all the same due to the positive impact on tenant credit quality.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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