Big tech stocks surged. Why the little ones didn’t.

Text size

One of the big stories in the markets this year has been the surge in tech stocks. This has mostly been true for the stocks of the biggest tech companies, not the smaller ones.

Metaplatforms

(symbol: META),

Microsoft

(MSFT),

Alphabet

(GOOGL),

Nvidia

(NVDA),

Apple

(AAPL) and Amazon.co.uk (AMZN) are all up double digits in percentage terms this year. Nvidia and Meta almost doubled.

All went well for Big Tech. First, valuations rose because long-term securities bond yields fell as the market anticipates a pause in Federal Reserve interest rate hikes. These lower returns increase the present present value of the growing profits these growing companies are expected to generate for years to come.

At the same time, analysts are more optimistic about earnings. Analyst forecasts for 2023 earnings per share have risen this year for all of these companies except Amazon, according to FactSet.

First-quarter earnings at Meta and Alphabet were better than expected, in part because a recent slowdown in ad spend growth appears to be stabilizing, with positive effects on margins. Microsoft has exceeded forecasts and artificial intelligence improves its cloud products. And advances in AI could increase demand for Nvidia chips.

Small tech companies were less fortunate. The iShares Russell 2000 Growth Exchange-Traded Fund (IWO), which counts the technology sector as its second largest weighting, has gained just over 3% this year. Slowing economic growth is raising concerns about their revenues, a problem compounded by competition with big tech companies.

And even though interest rates have recently fallen, it is still much more expensive to raise funds than it was before the Fed started raising rates just over a year ago. Valuations are lower, so issuing shares is a less attractive option. This poses a problem for any small business that is still trying to raise capital to fund its growth.

“There’s still the whole question of where rates are going, the fear that rates will stay high,” said Jason Ader, technology analyst at William Blair.

A few examples in various tech industries stand out.

The $2.2 billion by market capitalization of Jamf’s holdings (

Jamf

), which continues to expand its security and management software for Apple products worldwide, has seen its stock drop about 15% this year. The company generated $82 million in free cash flow last year, but it recorded $99 million in stock-based compensation expense.

If the company had paid this amount to staff in cash, it would have been in the red in terms of free cash flow. The ultimate concern is that if the business does not turn out to be very profitable, it may eventually have to rely on external funding, which is now harder to come by. He has just over $220 million in cash.

Management’s weak sales forecast in February did not help this picture. The company told investors to expect annual sales of $561 million and operating profit of $39 million, both below consensus estimates. RBC analysts wrote that management appeared cautious as some clients watch their technology budgets.

Jamf did not immediately respond to a request for comment.

The $4.7 billion

Gitlab

(GTLB), which provides business applications aimed at uniting and making teams of software developers more efficient, has seen its share price drop by just over 30% this year. In March, management told investors to expect sales of $531 million for fiscal 2024, nearly $9 million lower than analysts had expected.

This call implied growth of around 26% year-over-year, compared to around 68% in 2023. This company also issued a cautious outlook as some customers lay off developers and Gitlab’s application is sold per user. , explained Ader.

Additionally, he said, investors fear Gitlab could lose market share to larger players in light of Microsoft’s AI advancements.

The good news is that liquidity is not an issue for Gitlab. The company has about $900 million in cash and cash equivalents and is only expected to use about $28 million in fiscal 2024, thanks in part to its stock-based compensation. It theoretically has more than a decade of cash on hand and could even start generating free cash flow next year. The company did not comment.

Some of these small, downed tech stocks will struggle to come to life, but some could be good assets for growth investors.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com