By Philip van Doorn
Technology stocks have been rallying for weeks.
But there are plenty of arguments that we’re in the midst of a bear-market rally and that more volatility lies ahead, especially for the rapidly growing, but not necessarily profitable, technology stocks that performed so well during the previous bull market through late 2021.
Robert Stimpson, chief investment officer for Oak Associates Funds, made the case that a “financials first approach” to companies with staying power is the best one for the current environment, with risks that include rising interest rates and a possible recession.
During an interview, Stimpson, who has been with the firm for 21 years and co-manages the $544 million Red Oak Technology Select Fund /zigman2/quotes/206371872/realtime ROGSX -0.66% , described his team’s approach to selecting large-cap tech stocks for “attractive valuation, high profit margins and an ability or willingness to support and recognize shareholder value.”
That last part might include share buybacks, which increase earnings per share, dividend increases or acquisitions expected to increase earnings per share.
The fund has a low-turnover approach, currently holds 26 stocks and has a four-star rating, the second-highest, from Morningstar.
A company doesn’t necessarily have to pay a dividend to be among the fund’s holdings, Stimpson said, but “it has to show respect for investors,” which includes a “non-hubristic approach to acquisitions.”
A closer look at the tech-stock rally
Here’s a one-year chart showing the movement of the Nasdaq Composite Index /zigman2/quotes/210598365/realtime COMP -0.59% :
The Nasdaq has rallied 23% from its 2022 closing low on June 16 and it is now down 17% for the year. The Nasdaq-100 Index /zigman2/quotes/210598364/realtime NDX -0.73% — which includes the 100 largest nonfinancial stocks in the full Nasdaq — is also down 17% this year. But even after its own 22% rally since June 16, 23 of the Nasdaq-100 are still down between 30% and 59% for 2022.
To be sure, the Red Oak Technology Select Fund hasn’t escaped this year’s broad decline — it has fallen 17% for 2022.
Despite the better-than-expected inflation numbers for July, the Federal Reserve is expected to stay the course and continue raising interest rates to cool the economy. Rising interest rates always put pressure on stock prices — even more so for tech stocks. That’s because their gains had been driven by sales growth, or even by emotional reactions to their potential for “disruptive innovation,” rather than increases in profit, cash flow and deployment of capital in ways meant to benefit shareholders.
“When we were in a zero-interest-rate environment, the acceptance of risk was much higher. Capital was cheap and companies that were not expected to become profitable for a while were acceptable,” Stimpson said.
Looking ahead, he recommends investors avoid investing in companies on the expectation that they will eventually grow into current valuations that appear “lofty.”
Stimpson was quick to agree that the Red Oak Technology Select Fund’s “high-quality blue-chip approach” to tech stocks underperformed during the last bull market.