A frantic undoing of the pandemic-era tech stock mania has clobbered the entirety of the Canadian IT sector, erasing two years’ worth of soaring gains in a little more than four months.
This week, flashes of panic selling took what has been a harsh but orderly sell-off to alarming proportions, turning the software space into a minefield for investors.
But there are rare opportunities emerging, if you tread lightly.
“There are a lot of bad companies out there that were spending way too much money on growth and they will go away,” said David Barr, chief executive of Vancouver-based PenderFund Capital Management. “The really great businesses will be able to dial back their spending and stay profitable. And where their prices are today, it’s a fantastic opportunity.”
A good place to start, Mr. Barr said, would be among the sector’s more conservative and profitable names – two qualities that went undervalued for much of the past two years.
In the minds of many investors, the pandemic permanently supercharged society’s digital transformation, resulting in a ravenous demand for stocks tied to e-commerce, remote work, cryptocurrencies and more.
As in previous tech bubbles, the stock market came to prize rampant growth above all else, affording unprofitable companies generous valuations based on multiples of sales growth – in the case of Shopify Inc. SHOP-T, as high as 50 times trailing revenue. The stock market as a whole trades at a small fraction of that.
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Investor appetite for stocks richly priced for their future potential has collapsed.
“After this crazy run, you knew the market wouldn’t reward companies like this forever,” said Bryden Teich, a portfolio manager at Avenue Investment Management. “Still, it’s been shocking how violently the FAANG-like names have been sold off.”
Those Big Tech stalwarts, venerated by investors around the world through the depths of the pandemic, each dropped by between 5 per cent and 8 per cent on Thursday alone. The tech-laden Nasdaq Composite Index has dropped by 24 per cent so far this year.
“This is a function of people trying to get out at any price, whereas a year ago, people were willing to get in at any price,” Mr. Teich said.
Pity the companies putting out bad news in the midst of all that. Shopify missed the Street’s earnings estimates by a wide margin, and its stock was hit with a 14-per-cent drop on Thursday.
The Ottawa-based e-commerce company’s stock is now down by 77 per cent since last November. Investors need to forget about Shopify’s previous highs, Mr. Teich said.
“Even though that was only six months ago, that was a different world.”
Instead, investors might be better off looking for companies with the profits to withstand the crash, and that might ultimately benefit from the market turmoil.
Constellation Software Inc. CSU-T, for example, has made a business model out of acquiring smaller software companies by the hundreds. And it has enough cash flow to fund those deals internally.
Other acquisitive companies, such as Lightspeed Commerce Inc. LSPD-T, relied on tapping equity markets to make deals. That wasn’t a problem when its stock was trading at a towering valuation last year. But Lightspeed’s shares are now down by 84 per cent.
“Lightspeed as a revenue-growth model doesn’t exist any more – their source of capital has basically just evaporated,” Mr. Teich said.
Constellation, on the other hand, will be in a position to capitalize on the plunge in tech valuations to secure cheap deals.
Other pockets of tech space might avoid the worst of the correction. Some business-to-business software companies might be able to sidestep the pressures on consumer spending, Mr. Barr said, naming Vancouver-based Copperleaf Technologies Inc. – whose products help companies plan their capital spending.
“We think a lot of companies are going to invest more into their energy infrastructure, and that’s a big tailwind for Copperleaf,” Mr. Barr said. The company’s shares are down by 61 per cent since peaking shortly after going public last October.
Many other solid companies are seeing their stocks unduly punished just by virtue of being part of the tech sector. Thinkific Labs Inc. is a prime example, with its stock down by 87 per cent over roughly the past year, Mr. Barr said.
“What people are missing is that this was a profitable, bootstraps tech company pre-IPO,” he said.
“If you buy a basket of high-quality tech companies today, you’re going to be really happy five years from now.”
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Tim Shufelt