Tech leaders are 'trying to reset metrics' amid economic headwinds, analyst explains

TECHnalysis Research President and Chief Analyst Bob O'Donnell joins Yahoo Finance Live to discuss the tech industry, generative AI, growth opportunities, the state of the economy,
and the outlook for tech companies.

Video Transcript

JULIE HYMAN: It is time now though, for today's Morning Brief. We're putting tech in the hot seat. Traders may want to proceed with caution despite what's been a throwback boom year for the tech trade. In the midst of what's been a fairly turbulent time in 2023, the tech heavy NASDAQ composite has enjoyed gains beyond that of the S&P 500 and Dow Jones Industrial average.

However, with macro risks hanging overhead, the red-hot tech trade may come tumbling down. Here to discuss we have TECHnalysis Research, President, and Chief Analyst Bob O'Donnell hanging with us in the studio today. And he's going to be with us for a bit. So thank you so much for being here, Bob.

BOB O'DONNELL: Thanks for having me. Looking forward to the chat, yeah.

JULIE HYMAN: So we were just talking to Lori Calvasina of RBC a little bit about this idea, that growth has been strong, but there are questions and there really have been questions about that momentum. What do you think?

BOB O'DONNELL: Well, you know, I thought she brought up a great point to distinguish between the internet companies versus the traditional tech companies. Because a lot of times that stuff gets thrown together and they're very different businesses and they function in different ways. So the fundamental thing that I'm looking at is, obviously, we've seen some major corrections with some of the traditional hardware guys.

The semi guys, the PC companies, all those kinds of names, the network equipment company, and they're kind of shifting things around. Obviously, dramatic layoffs, cost-cutting measures, all of those things are pointing towards saying, hey, we know we kind of went overboard, we need to move forward. I think it's going to take a while, but I do feel fundamentally that you still have a lot of opportunities there.

Because what happened during the pandemic? Let's not forget is we all became utterly dependent on technology products and services in a way that we never did. Things we always thought were going to happen or might happen from remote work and remote school, we've been through all that now. We understand where they work, frankly where they don't.

But all of those give us an opportunity to look forward. And also some of those internet services are-- they've become part of what we do. The way-- you guys were talking retail. Obviously, how much we now depend on online retail and all those things, all of that dramatically changes. And the companies who are enabling those services, it may not be that target doing that work, right?

They're working with software companies and other services to help them with their supply chain and all those kinds of efforts. So I pull back, I look at all those things and and I think, hey, these are all fundamental opportunities for growth in the long-term. And so I think there is going to be some noise in the short-term. We can't deny that.

And I think there's going to be another quarter or two that could be kind of tough. But if I'm looking out further ahead, I do think there's plenty of opportunities. And oh, by the way, haven't even mentioned the magic word, generative AI, and so I know we'll get to that later. But people are going to start using technology products and services I think in fundamentally different ways because of some of these advancements that we're starting to see.

And again, that opens up a lot of opportunities. I think there's a lot of confusion to be clear on exactly where some of these things are going to go, but it's also very interesting. I've been to every tech conference I've been to over the last couple of weeks, all people want to talk about is what they're doing around AI.

I was at IBM Think last week in Orlando, Intel Vision, was up at Amazon not too long ago, Microsoft events, all these guys, they're all grappling with and thinking about, hey, what can we do here? And I think that's going to lead itself eventually into some fundamental changes. And to be clear, I think it's different than the crypto stuff and all that because I think that was noise.

BRAD SMITH: And so as they're making a lot of major investments into either their own research and development or other areas of the business where they're hoping it will be additive to the bottom line. In this near term for some of the pandemic darlings even, it's about what this next phase of, I think if I'm summing this up correctly based on what you were saying, normalization looks like for their business and how dramatically different they could look as a scaled entity to three months and two years from now even.

BOB O'DONNELL: It's a great question, Brian. And you know, I just-- Brad, excuse me.

BRAD SMITH: It's OK. All good.

BOB O'DONNELL: I think that they are trying to reset things in terms of how they're thinking about this and the way the sort of projects they're going to go after, right? I mean, one of the things that happened during the pandemic that where they blew up is they started doing a lot more of these long shot kinds of projects, and a lot of the things that got cut back on and a lot of the job loss unfortunately was around some of these longer shot things.

So I think they're more focused now on their fundamentals, they're determining where are the places they're the strongest. Where are the closest places they can go to next and then trying to build out from there. And the other thing to remember is we're also in the midst of a multi, probably a decade long at least, digitization of almost everything, right?

We've talked about this for a long time as an industry, but now we're really seeing it. You've got smarter versions of everything from home electronics to obviously our cars and all of these things. Those trends are going to continue. And again, we're going to see a little bit more interest there because of not only the hardware that's enabling these things and all kinds of interesting new semiconductors, but the software.

And we're also seeing different companies, again, moving to adjacencies that make sense. A lot of these big tech companies, for example, that were traditionally software companies, they're starting to design their own chips. You see Microsoft doing this. You've seen Google doing this. You've got Amazon doing this. There's all these companies that you don't think of in those areas that are starting to participate.

And then you've got lots of little specialized companies coming in from different places. I happen to be in town this week for a Lattice Semiconductor analyst event. That's a small semiconductor company, those FPGAs, very specialized types of devices, but they're used in all kinds of different places, industrial equipment, in automotive, in telco. And they've done very well throughout all of this.

So there's a lot of different places, and little holes, and nooks, and crannies where you can find a lot of interesting tech companies I think. And I think that's going to contribute to this bigger picture.

JULIE HYMAN: The question is, though, are they priced appropriately, right? And I know you're less the stock guy and more fundamental guy, but that's really to me the crux of the question is, normalization. It's a growth slowdown. Let's call it what it is, right?

And so given the price action that we have seen, particularly this year, even where valuations sit now at a time when rates are still moving higher or they are at least remaining at a relatively high level. That's the question investors have to ask themselves. What are they paying for right now? What are they getting for that?

BOB O'DONNELL: It's a great question, Julie. And if I knew the answers to those questions, I'd be sitting somewhere else. But no, look, the reality is I think there are some serious questions about valuations that are fair to ask. The part of the problem, I think, is people are trying to reset their metrics, right, like you said.

What are the right metrics now? What do we think about? I mean, from everything from, gee, is it do we really want to look at monthly active users for some of these big internet-based companies? Or is there some other metric that we need to be thinking about? And I think that's--

JULIE HYMAN: Are they making money? That's it--

BOB O'DONNELL: Well, yeah, I mean--

JULIE HYMAN: That one's coming back.

BOB O'DONNELL: Exactly, I know. But you're absolutely right. I mean, are they making money? Again, I think some of this is coming back to those fundamentals. And the question is, how can financial professionals figure out the best way to figure out new metrics to really measure these companies. And I think we are-- I think we're in the midst of that.

I think people are trying to figure that out. And I think it's not entirely clear, and again, I think part of it is we've had too much of this just throw all tech in the same bucket. And as you start to pull it apart, I think you can get a little bit smarter about, hey, these kind of companies, I think, are better measured this way. These kind of companies are better measured this way, et cetera. So I think that's part of what it's going to be.

BRAD SMITH: Part of the spending that you were kind of laying out amid this period of normalization, rescaling for their businesses as well. Does that mean that, from your perspective, investors might have to be comfortable with an extended period of margin compression and not seeing the pre-pandemic margins that they had become accustomed to even in this near term?

BOB O'DONNELL: It's a good question. I mean, I think there certainly is that. I mean, again, as they've had to reshuffle their businesses and think through this, I mean, we've seen, as you said, some of the biggest tech hardware guys in particular have huge margin compression, especially on the chip side.

I mean, Intel going from the 60s down to the 30s, right? I mean, it's just crazy to see that. So yeah, I think there is going to be-- and it's going to be a long time, by the way, I think before they get back to those kind of levels. So to your point, I think, investors do have to think about that. I know a lot of people don't have the appetite for the super long look aheads.

But I feel like especially in some of these things, like semis, that's what it's going to take, because it's not like we're not going to need less chips. There's no question we're going to need them, but how is the business run? How do the fundamentals change? How do they start making more money? And I think some of those questions still remain.

I do think there's interesting new opportunities. And again, I think we're going to see, in the case of semis in particular, more companies get into it. It's not going to be their core business, but they're going to be doing it, and that's going to help drive the whole economics around fabs and things like that.

JULIE HYMAN: And then, on the flip side, you have companies, like Nvidia, that now make software too. So there's that aspect of it.