Below is a summary of an article titled ‘Taming the masters of the tech universe’ by Martin Wolf which was published on 16 November on www.ft.com.
Eight of the world’s twelve most highly valued companies are technology businesses, as highlighted in Martin Wolf’s, Taming the Masters of the Tech Universe. Apple is the largest of them with a market capitalization approaching US$900 billion. Barring a major loss of competitive position, it could potentially become the world’s first trillion dollar company in the years ahead. Most of the tech juggernauts are American, however two are Chinese (Alibaba and Tencent Holdings) and one is Korean (Samsung Electronics).
Many worry that such tech dominance is setting up another “tech wreck”, as occurred when the dotcom bubble burst in 2000/01. However, there are some major differences between now and then.
Most of the large tech companies are solid businesses generating real profits and cash flows, rather than just promises of future profits. As a result, equity valuations are a lot less stretched than during the dotcom bubble. There are fewer instances of “new age” valuation metrics being used such as multiples of revenue (Snap, the owner of Snapchat, being a possible exception).
The current 12-month forward PE ratios for the eight largest tech stocks are Apple 14.7x, Alphabet 21.0x, Microsoft 23.9x, Amazon 73.1x, Facebook 24.6x, Alibaba 30.4x, Tencent 38.9x and Samsung Electronics 7.9x. Some of the valuations might turn out to be excessive. But in many cases the PE ratio is similar to the expected compound annual growth rate in EPS over the next 3 years, possibly justifying current valuations. Amazon stands out as the stock with the highest near-term PE ratio but is being bought on much longer timeframes given its market dominance in certain sectors and disruptive potential in others.
Bond yields are much lower this time too, justifying higher PE ratios all other things being equal. Back in 2000/01 US 10-year Treasury yields were around 5-6%, compared to about 2.4% now. The wider spread of tech companies between the US and Asia is also a healthy development. The businesses in which the tech companies are engaged are different in many respects or are geographically separated, ranging from software, computer hardware, mobile phones, semiconductors, televisions, online retail, media (including social media), gaming, search and advertising.
The capacity of the digital economy to transform economies and societies is becoming clear enough. To be not part of it is to miss out on future growth drivers. The largest tech company in Europe is the enterprise application software and database company, SAP, which only ranks as the world’s 60th most valued company. (The most valuable listed European company is Royal Dutch Shell.) Australia’s tech sector is also relatively underdeveloped.
One of the difficulties of investing in tech companies is trying to estimate the longevity of a particular company’s competitive advantage. Innovation and economies of scale, including network externalities that lock in customers, can deliver sustainable, super-normal profits. So can monopolies/duopolies where they exist, e.g. protected markets in China. However, the potential for disruption by smaller innovators is always present.
In Martin Wolf’s article, he mentions a number of difficulties for governments and regulators to grapple with in relation to tech companies, particularly around competition policy, taxation, surplus cash, impacts on labour markets, media policy (e.g. fake news) and privacy. The tendency of large tech companies is to acquire competitors and potential competitors to entrench competitive advantage. Google and Facebook alone are expected to receive 63% of all US digital advertising revenue in 2017, and many tech companies pay very low tax rates and have a lot of cash sitting offshore that could be invested more productively.
Whatever the challenges for governments, tech companies will continue to transform the world and deliver strong earnings growth for shareholders. It is always possible to overpay for good companies but, in most cases, the worst excesses of the dotcom era are not present now.