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Pathikrit Bose

3 Overheated Tech Stocks to Skip This Summer

Stocks in the technology sector have created massive wealth for investors in recent years. Fueled by the artificial intelligence (AI) megatrend, tech stocks have delivered gravity-defying rallies that have single-handedly propelled the overall markets higher. This can be gauged from the fact that the “Magnificent Seven” stocks alone collectively added a staggering $5.1 trillion in total market cap during 2023, and the universe of all U.S.-listed stocks would have advanced by just 12.6% last year without the Magnificent Seven's influence, compared to 23.3% with their returns included - and data this year suggests returns are even more lopsided.

However, while some top AI names are already turning the technology into revenue, the widespread investor enthusiasm can also create pockets of overvaluation. For some stocks swept up in the AI narrative arc, the short-term gains in their share prices have run ahead of the fundamentals, even where the longer-term growth story remains intact.

While investors who already own these overheated stocks might feel comfortable riding out any short-term pullbacks, it's likely not the best time for new buyers to pick up shares. To that end, brokerage firm Morgan Stanley (MS) has recently called out three stocks from the red-hot tech sector that look a little overvalued, are trading perilously near Wall Street's consensus price targets, or just have a troubling lack of catalysts to push them higher in the short term.

#1. Pure Storage

Founded in 2009 with the mission to revolutionize the storage industry by offering faster and simpler storage solutions, Pure Storage (PSTG) provides software-defined all-flash storage solutions designed for speed and cloud compatibility. They are known for their "Evergreen Storage" model, which eliminates the need for frequent hardware upgrades by offering subscription-based software updates and support. Its market cap currently stands at $21.4 billion.

PSTG has had a stellar 2024 so far, zooming 80.8% higher on a YTD basis.

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For Q1, Pure Storage's results impressed, with revenue and earnings surpassing estimates. Revenues for the quarter increased by 18% from the previous year to $693.5 million, backed by substantial growth in its core subscription revenues. EPS quadrupled in the same period to $0.32 from $0.08, comfortably outpacing the consensus estimate. In fact, Pure Storage's EPS have topped expectations in each of the past five quarters.

However, the rally in Pure Storage's share price has left it looking expensive, as the stock now trades at 41x forward earnings and 6.85x sales.

Further, Pure Storage faces competitive risks from the variety of storage solutions offered by large players like Google (GOOG), Amazon (AMZN) and Microsoft (MSFT) as part of their cloud services. The company also faces a growing challenge from Original Equipment Manufacturers (OEMs) and white-label Original Design Manufacturers (ODMs) entering the all-flash storage market. This surge in competition could put pressure on Pure Storage's pricing and profit margins if they are unable to maintain their position as a market leader. Therefore, Pure Storage must focus on strategies that solidify its competitive advantage and brand recognition.

Morgan Stanley recently downgraded PSTG stock to “Equal-weight” from “Overweight,” while maintaining its price target of $60, remarking “While there is likely a large cloud deal to come and TCO/power advantages remain, cloud deal revenue and the majority of AI revenue still further down the road, meaning estimate revisions are more limited in the near term.”

Overall, analysts have a rating of “Moderate Buy” for PSTG stock with a mean target price of $68.95, less than 7% above Friday's close. Out of 20 analysts covering the stock, 12 have a “Strong Buy” rating, 2 have a “Moderate Buy” rating, and 6 have a “Hold" rating.

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#2. Corning

Founded as Bay State Glass Co. in 1851, Corning (GLW) is a diversified technology company with a long history of innovation in materials science. Their core businesses include its Specialty Material division, which produces the highly popular Gorilla Glass for consumer electronics, optical fiber for telecommunications, and other specialty glass and ceramic products. Its two other core businesses include the Display Technologies segment and the Life Sciences Vessels segment. The company currently commands a market cap of $34.1 billion.

Corning stock is up 31.5% on a YTD basis, and it offers a dividend yield of 2.81%.

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For Q1 2024, Corning reported core sales of $3.26 billion, down 3% from the previous year. EPS came in at $0.38, declining 7.3% year over year - but topping the consensus estimate for an EPS of $0.35.

Corning closed the quarter with a cash balance of $1.37 billion, down from $1.78 billion at the start of the year. That's well below its total debt levels of $8.29 billion. 

Longer term, Corning could benefit from growth in AI data center demand and infrastructure projects, which will require an increased number of fibers for building CPU capabilities suitable to handle AI capacity loads. Plus, with the adoption of new EPA standards by 2031, Corning's overlooked environmental technologies division, which makes gasoline particulate filters, could receive a boost. Management expects for filter adoption requirements to begin as early as 2026.

That said, Morgan Stanley just downgraded the stock to “Equal-weight” from “Overweight,” citing a more balanced risk-reward at current levels. The firm simultaneously raised its price target on GLW to $38.

Overall, analysts have deemed Corning stock a “Moderate Buy,” with a mean target price of $37.38 - which indicates expected downside of about 6.5% from current levels. Out of 11 analysts covering the stock, 5 have a “Strong Buy” rating and 6 have a “Hold” rating.

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#3. Twilio

Founded in 2008, Twilio (TWLO) is a cloud communications platform that provides software developers with Application Programming Interfaces (APIs) for integrating voice, video, messaging, and authentication functionalities into their applications. This allows businesses to easily add communication features like SMS notifications, two-factor authentication, and video conferencing to their products without building the infrastructure themselves. Its market cap currently stands at $9.15 billion.

TWLO stock is down 27.8% on a YTD basis.

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Twilio's results for Q1 2024 came in above expectations, with both revenue and earnings surpassing estimates. Revenues went up by 4% over the previous year to $1.05 billion as active customer accounts increased to 313,000 from 300,000. Further, EPS shot up by 70.2% to $0.80, coming in above the Street's expectations for $0.59. Notably, Twilio's EPS has constantly grown over the past five quarters while also beating the consensus estimates.

However, analysts were disappointed with Twilio's Q2 revenue guidance, which came in lighter than expected at $1.06 billion, at the midpoint. An additional concern for investors is whether persistent customer turnover within the Segment business might hinder Twilio's overall growth trajectory. Lastly, maverick investor Cathie Wood's complete exit from the stock, carried out over the past several months, has been noteworthy as well.

As for Morgan Stanley, the firm's downgrade of TWLO stock to “Equal-weight” from “Overweight” was triggered by a lack of top-line catalysts over the next 12 months, with analyst Meta Marshall noting that the "majority" of operating leverage has been realized, with the caveat that “We still like the long-term story.”

That “long-term story” includes Twilio's AI capabilities, which include embedding generative AI across its platform. Moreover, Twilio's CustomerAI, a suite of predictive analytics tools launched in 2023, has already been adopted by over 150 customers. This AI offering helps businesses identify sales opportunities and personalize recommendations for cross-selling and inventory management. Additionally, Twilio leverages partnerships with industry leaders: Google provides advanced analytics capabilities, and their collaboration with OpenAI on GPT-4 integration will bolster Twilio's AI-powered offerings for its 300,000-strong customer base.

Moreover, Twilio's customer engagement platform is accessed by over 10 million developers globally, helping it become a Communications Platform as a Service (CPaaS) powerhouse.

Overall, analysts have a rating of “Moderate Buy” for TWLO stock, with a mean target price of $69.08. This denotes an upside potential of about 26.2% from current levels. Out of 29 analysts covering the stock, 10 have a “Strong Buy” rating, 1 has a “Moderate Buy” rating, 16 have a “Hold” rating, 1 has a “Moderate Sell” rating, and 1 has a “Strong Sell” rating.

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On the date of publication, Pathikrit Bose did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
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