3 US tech shares to avoid
These shares have surged in price in the last year but are significantly overvalued according to our analysts.
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The following 3 US tech shares have been on a strong run. It can be tempting to assume those strong returns will continue into the future but our analysts believe all of them are significantly overvalued.
KLA Corp (NAS: KLAC)
KLA shares are up 85% over the last year. KLA is one of the largest semiconductor wafer fabrication equipment, or WFE, manufacturers in the world and has been caught up in the semiconductor frenzy. The shares are currently trading at over a 60% premium to our fair value of $530.
There are many things to like about KLA. We expect its unmatched breadth and depth to defend and increase its market share. We believe trends toward higher complexity in chips will drive increasing demand and strong pricing for KLA’s equipment, including artificial intelligence and new technologies like high-bandwidth memory. We particularly like that KLA boasts the highest profit margins out of any WFE firm under our coverage.
We assign a wide economic moat rating to KLA, resulting from strong design expertise and steep customer switching costs. KLA holds a majority share of the process control segment of the WFE market, wherein machines inspect semiconductor wafers during research and development and manufacturing for defects and verify precise measurements. KLA more than quadruples the sales of its nearest competitor, Applied Materials, in this segment.
We believe this share is built on KLA’s research and development budget of over $1 billion annually, which has helped it develop a comprehensive process control portfolio that spans the cost, performance, and product spectrum for its customers. Once in a customer, the complexity of KLA’s equipment and its embedded services make it sticky. In our view, this proficiency also gives it unmatched pricing power, with industry-leading gross margins in the low 60% range and strong cash flow.
We expect KLA to be prone to cyclicality in the semiconductor industry, but to increase revenue over the long term. The firm’s sales are a function of global chip volumes and overall chip complexity, and while we see cyclicality in the former, we see durable growth for the latter. More-complex chips that use gate all-around transistors, 3D structures, and require advanced packaging should fuel growth for KLA, in our view.
We monitor for geopolitical risk affecting KLA via export restrictions applied between the US and China, but see these controls primarily having an impact on lithography equipment and chip designers thus far. Finally, we like KLA's significant shareholder returns funded with its heady cash flow.
Lam Research (NAS: LRCX)
Another semiconductor share Lam Research is up 73% over the last year. Lam is one of the largest providers in the world of wafer fabrication equipment for semiconductors. The share are currently trading at a 57% premium to our fair value of $680 a share.
This is another strong company that we feel is significantly overvalued. We believe its strong portfolio, particularly for memory chip production, should enable it to maintain and increase its large market share.
We assign a wide economic moat rating to Lam, underpinned by strong chip manufacturing expertise and steep customer switching costs. Specifically, Lam holds a dominant market share in etch, a competitive position in deposition, and is highly penetrated in memory customers.
We believe its large research and development budget, at about $2 billion annually, creates immense design prowess for WFE and is to credit for its impressive market share. We also think the complexity of its equipment and its embedded services are very sticky. We see Lam’s moat resulting in pricing power that drives strong profit margins and good cash flow.
We expect Lam’s results to vary with the cyclicality of the semiconductor industry, but believe it will grow over the long term. The firm’s sales are a function of global chip volumes and overall chip complexity, and while we see cyclicality in the former, we see durable growth for the latter.
Trends toward rising layer counts in 3D NAND chips, high-bandwidth memory DRAM chips for artificial intelligence, gate all-around transistors and advanced packaging will drive demand for Lam’s equipment and revenue growth through cycles, in our view. We monitor for geopolitical risk impacting Lam via export restrictions applied between the US and China, but see these controls primarily impacting lithography equipment and chip designers thus far. Finally, we like Lam’s significant shareholder returns funded with its heady cash flow.
SAP (NYSE: SAP)
SAP is up over 47% in the last year. SAP is a best-in-breed enterprise resource planning provider and holds dominant market share in global enterprise resource planning (“ERP”) software. The shares are currently trading at a 42% premium to our fair value estimate of $144.
SAP is phasing out its support of its on-premises ERP software such that by 2040 all of its ERP customers will need to shift to a cloud solution. We think that this vulnerability is a significant threat to SAP’s switching costs, as competitors like Workday offer compelling cloud ERP solutions, while forced migration opens up opportunity to question a company’s best fit for ERP needs. In turn, we believe SAP’s narrow moat, derived from its switching costs, is trending negative. However, it is still early in SAP's transition of on-premises users to the cloud, which leads us to believe its negative trend could be prolonged.
ERP is not SAP's only offering. The company offers software in its so-called intelligent spending category, which includes Ariba and Concur, which cater to procurement and travel and expense reporting.
While ERP and intelligent spending software caters to operational data—otherwise known as O data—SAP also provides solutions around X data, or experience data. SAP has further entrenched itself in X data with its acquisition of Qualtrics experience management software. But, regardless of which type of data is flowing through SAP software, this data can be stored in SAP’s database offering, HANA, which is the only database compatible with SAP’s cloud ERP, S/4HANA (unlike on-premises ERP’s former database interoperability).
Despite SAP’s efforts to nurture high attach rates among offerings amid the vulnerable transition to the cloud, such as via database lock-in, we think this is only ruffling more feathers among its customers that have adapted to the new norm of mix-and-match technology, which the cloud has enabled. We think such lock-in attempts were influential in SAP’s historically declining net promoter score. Moreover, SAP’s efforts to add to its ecosystem in the hopes of more effortless user experience have proved to be anything but accretive, as its acquisition of Qualtrics has shown. SAP announced plans to spin off the company only two years after it was acquired.
