The Overpricing of Technology

One member invested in technology stocks makes the point that most big technology stocks (Amazon) lost money for years and on that basis the stocks we consider to be in a bubble at the moment, which are losing money (APT, XRO), might not be a sell. My response is that you may be right but you are talking about a long timeframe and we are concerned with a much shorter-term timeframe, and the risk that there may be a bubble in prices now that could deflate/burst at some point. It will not change the long term. The bubble observation is not about the long-term success of APT or XRO, it is about the short-term price risk and it’s a choice. Even if you knew for sure that APT would be a successful long-term investment, you would still want to buy when the price is low not high, and at the moment it is in the middle of a frenzy. Hope that makes sense. Meanwhile, another Member sent me a great bit of research from Capital Economics called “Can the S&P 500 continue to count on Big Tech”, Big Tech being Apple, Alphabet/Google, Microsoft, Facebook, Amazon. After Saudi Aramco they are the largest companies in the world. Let me try and summarise it for you - and apologies to Capital Economics for bastardising their excellent insights: Here is a chart of the performance of the big tech stocks in the US compared to the rest of the market. Their combined market cap has risen by about 16% since the virus hit the market in mid-February, while the rest of the S&P 500 has fallen by around 10%, and mid- and small-cap equities have fared even worse. The PE of these stocks is now 40x which is double the rest of the market. This is a chart comparison of the PEs of Big Tech versus the rest of the S&P 500: What makes a good technology stock long term, how did the big six do it? Like this:

• An offering that can scale globally and online.
• Being vital to the economy. The big six offerings include operating systems, online advertising, online search, social media/communications, office software, cloud computing. The economy cannot do without them so government will promote/ignore them rather than interfere with them.
• Not paying as much tax as everyone else. These are tax rates over the last two years.

• Never letting their competitors get big enough to pose a serious challenge (by buying Skype, WhatsApp, Instagram). The big six have made hundreds of acquisitions. This has added growth well in excess of base economic growth. It has also enabled consistent growth whatever the economic backdrop, because they are growing their market share.
• An environment that allows acquisitions and monopolies to move forward unheeded. Trump’s pro-business presidency following eight years of Obama’s permissive administration has been a gift and why these companies have been so successful in the last decade. They have had free reign without antitrust issues. The last time the government showed any attention to antitrust issues was 1998, with the U.S. Department of Justice and the Attorneys General of twenty U.S. states suing Microsoft for “illegally thwarting competition in order to protect and extend its software monopoly” by forcing computer makers to include its internet browser as a part of the installation of Windows software. That was under Clinton. Over twenty years ago. The lack of ‘Imperial interference’ as they grew their market share, profitability and conducted hundreds of takeovers has been vital to the decade of growth in the big six.
• A coronavirus. It has accelerated industries that do not require face-to-face.
• A coronavirus. It has strengthened the cash rich behemoths over smaller, cash-hungry, growing competitors, allowing them to take stakes and make bids of weakened competitors. Tencent buying into APT. The big six have announced 18 acquisitions since February.

The conclusion from Capital Economics is that even a new tax crack down, or a new antitrust environment, is only ever going to shave a few percentage points off profitability now and “would not fundamentally change the underlying factors driving their growing power”. What was the code of that FANGS+ ETF again? Afterpay - The other interesting observation is that APT has a few elements of the big six, but lacks one major power. Cash. They have to have a capital raising to get it as they just did. This constant cash requirement separates them from the cash rich giants and that makes them vulnerable. It could not fight off the competition if it came hunting. It is a morsel in the global context. It is vulnerable to a takeover and maybe that’s how this glorious chapter will end – in the hands of one of a bigger company - Mastercard, Paypal, Visa, Tencent... Want to hear more from Marcus this reporting season? CLICK HERE to sign up for a 14-day free trial *no credit card required*