James Gard: Welcome to Morningstar. I’m delighted to be joined again by Michael Field.
So, Michael, we’ve had a tech selloff and now we’ve had a tech rebound. So where does that leave European tech investors?
Michael Field: So, I think tech investors are concerned. Of course, when a sector has rallied as much as it has done so far this year and carried the overall index to some degree, there’s always a little fear when stocks sell-off a little bit in Europe. But valuation-wise, thankfully, if we look through the stocks, it’s not a slam dunk that they need to come down or that valuations need to adjust ultimately.
Gard: So, you’ve picked three stocks as kind of bellwethers of the European tech sector. They are ASML, SAP and ARM, which technically a British company but listed in the U.S. So, two of those posted really strong gains so far this year, even including the sell-off. So, SAP is up 40%, ARM is up 85%. So, the sell-off hasn’t really registered.
Field: To some degree. Look, obviously, if you’ve been invested in recent months, you’re not going to be very happy. But ultimately, if you’ve been a longer-term holder in the story, it seems to be a blip. Look, expectations always need to adjust to the realities of the situation. But if you look at the growth posted by these companies and the kind of medium-term structural story that they’re talking about, SAP with cloud computing, the likes of ARM and ASML with the AI aspect, there’s plenty to be optimistic about even as a shareholder of these companies currently.
Gard: Sure. So, starting with ASML, it shows we’re only up 5% year-to-date, so hasn’t shot out the lights. But according to Morningstar metrics, the shares are still undervalued, but that’s – ASML is seen as the kind of the epicentre of European tech. It’s a kind of echo of NVIDIA. Not quite NVIDIA’s success story yet, but it is very much seen as a bellwether.
Field: Indeed. So, I think, look, there’s always a danger with hyping up the AI aspect of ASML, which is definitely not a pure AI play. Ultimately, they make the semiconductor machines that make semiconductors. So, it’s very much a second derivative in that aspect. But there’s advantages of that. They’re not purely exposed to one sector or industry. They’re quite diversified across the board. And again, we spoke about medium-term structural growth stories, and this definitely fits that bill.
Gard: Sure. So, moving on to SAP, it’s a narrow moat stock. It is screening as overvalued according to metrics, but it’s a pretty strong company within the German scene.
Field: Certainly. I think it’s one of the kind of tech companies that Germans and us Europeans point to in terms of comparisons to the U.S. and whether we have any kind of national champions in that regard. But look, yes, valuations are pointing to it being overvalued. But I think, look, if you look at the growth underlying the company, it’s very strong from that perspective. I think what we’re pointing at is just that there’s a slight difference in views between what the market expects now currently and what the company is able to produce.
Gard: Sure. And so, moving on to ARM Holdings, I know it’s listed in the NASDAQ. It’s a wide moat stock. It’s screening as a 1-Star at the moment. So, it’s had an 85% run-up this year, and the shares have doubled since its much-hyped flotation. Where does that leave investors, really? Because it’s clearly a beneficiary of this whole tech – I don’t want to say bandwagon – but certainly enthusiasm for all things tech?
Field: Indeed. And as much as we pointed to the tech sector and European stocks in general and saying there’s still value there, the likes of ARM Holdings is one of those kind of more egregious examples where expectations have just gotten way ahead of themselves. And we spoke about this before about in terms of expectations and we’ve pretty high expectations built in for this stock in terms of margins expanding quite heavily and revenue growth continuing for quite a long time. And we’re still getting to a valuation almost half of where the stock trades today. So that will just show you how high the expectations are for this company currently.
Gard: Sure. So, thinking of that, I mean, when there is a sell-off, if there is another sell-off, companies that are screening as overvalued by Morningstar metrics, would you say they’re more vulnerable to a correction and they pose more risk to investors at this stage?
Field: So, I think there’s two aspects of this. Sentiment being what it is, it’s sometimes a blunt instrument that kind of takes down everything and anything in sight or based on kind of current expectations. But I think, look, if we want to be fundamental about this, and that’s the kind of house we are, and if you want to be kind of pinpoint exactly where it’s most vulnerable from that perspective, yeah, indeed, we can pull up the most valued stocks or the stocks that we feel that are overvalued in Europe currently, and that’s where we should be steering clear of generally. But certainly, if indeed there could be another sell-off, they are definitely not places you want to be invested in, because even if things recover, we think these stocks, their valuations are too high to begin with.
Gard: Right. So, there’s vulnerability priced into that. I mean, things have calmed down since NVIDIA had a rally overnight. But there are risks still in the system. In terms of what could save the AI tech narrative, interest rate cuts seem to be the obvious way of keeping the market going. What else could you say? A bit of economic growth in Europe? I know things are pretty lukewarm at the moment. But what could keep the ball rolling?
Field: I think the macroeconomic factors that you spoke about, interest rate cuts, et cetera, obviously have a quantitative effect on the valuations of these companies and will improve the situation in the short term. But speaking specifically about AI, what we need now is the usage of AI and the integration of AI in day-to-day life and day-to-day companies to increase or to show itself over the next few years. And that kind of firms up the positive story that people have been spinning on AI.
Gard: Sure. I mean, we’ve had the hype. We’ve had the market valuations go up. But we need to see some sort of daily practical use of it. And there’s evidence that’s starting to happen. The new Apple iPhone is very strong with its AI, generative AI. So, it’s definitely – you can see it. There’s things moving in that area.
Field: I think that’s fair to say, yeah. But I think it’s just that next leg and that next – companies have been talking about it for quite a while. But it’s just to see those physical next steps put into place, and that will eventually firm up the story if indeed that comes to fruition.
Gard: Sure. Great. So, well, next time we meet, we’ll be talking, I think, about the U.S. election. And that really is a potential threat to the U.S. stock market as it is at the moment. But should we park that one there and address that next time?
Field: Absolutely. Look forward to it.
Gard: Brilliant. Thanks for your time and your insights, Michael.
