THE technology index is currently trading at a price-earnings (PE) multiple of 34.34 times, which is above the five-year average of 25.7 times.

Interestingly, apart from the V-shaped recovery in their share prices, most tech stocks have staged V-shaped rebounds in their PE multiples.

Among the star performers are UWC Bhd and Greatech Technology Bhd, whose share prices have soared 72.9% and 59.2% respectively year to date. UWC is currently trading at a PE multiple of 49.6, and Greatech Technology, at 34.9 times, significantly higher than their PE multiples of 27.7 and 21.2 times respectively at the beginning of the year, indicating the optimism of the investing fraternity.

The rally is seen across the board, including the big boys. For instance, Vitrox Corp Bhd is trading at a PE multiple of 55.8 times, Pentamaster Corp Bhd at 25.9 times, and Frontken Corp Bhd at 34.3 times — higher than their PE multiples of 25 to 46 times at the start of the year.

The proxies to the Apple supply chain, such as Inari Amerton (PE: 33.5 times), Globetronics Technology (28.2 times) and Malaysian Pacific Industries (15.6 times) have seen their PE multiples going up substantially since January.

What is mainly fuelling the tech rally is the expectation of the powerful deployment of new technologies in gadgets and devices used in daily life. That has led to the anticipation of exponential earnings growth and might remind veteran investors of the dotcom boom.

Given that most tech stocks have staged strong rallies since March, Rakuten Trade Sdn Bhd research vice-president Vincent Lau advises investors to exercise caution.

“I would advise investors to consider putting their bets on tech stocks that are still trading at reasonable valuations, which could be judged as laggards for catch-up play,” he says.

In his opinion, a reasonable valuation for Malaysian tech stocks would be sub-30 PE multiples.

Beware of frothy valuations

Lim Tze Cheng, head of research at EquitiesTracker Holdings Bhd, believes that as long a company’s growth justifies a stock’s valuation, there could still be some upside in share prices.

“In my opinion, a PE multiple of less than 30 in tech stocks is considered reasonable, but I would advise caution in applying a blanket approach in valuing tech stocks,” he says. He explains that this is because different firms operate in different parts of the supply chain.

Some investors may be using the price-earnings growth (PEG) ratio to justify high valuations, but Lim has his doubts about this metric. In his opinion, it is erroneous. “It is misleading to combine company valuations and growth rate in a single metric.

“PEG is adopted when analysts cannot justify the high valuations of a certain stock, and would still like to make a ‘buy’ recommendation,” he says.

Giving an example of two tech stocks with similar growth prospects, Lim says it is more logical to opt for the one that is trading at a lower PE ratio. “Valuations have to be justified by growth,” he points out.

Note: This article was first published on theedgemarkets.com