Early September would appear to have brought what many in the market had been cautioning: a reversal in the fortunes of high performing tech companies.
With the prices of leading tech stocks like Apple, Amazon and Microsoft touching on record highs in June, the underperformance in the early weeks of September may have caused some discomfort among investors who have enjoyed uninterrupted gains from the tech sector since the market bottomed in March earlier this year.
While Big Tech has led the market’s performance for much of the last decade and widened the gap since the onset of the pandemic, Victor Mupunga, Research Analyst at Old Mutual Wealth Private Client Securities, doesn’t think it’s another 1999 yet.
He said that leading up to the dot.com bubble, investors were willing to pay more than twice the multiple for the tech sector relative to the rest of the market.
“Today, we are nowhere near those levels. This is not to say the tech sector is cheap but rather to say that the comparison to 1999 is off the mark.
“The one big difference today is that the growth we’ve seen in the tech sector over the last few years has largely been driven by earnings,” he said.
Whereas many of the internet-focused technologies and companies 20 years ago were only just emerging, many have since morphed into established businesses that still display strong growth potential.
Mupunga pointed to the make-up of the S&P500 to illustrate this point. “If you look back to 1999, the tech sector contributed just 10% of the S&P 500’s earnings. Today, that number is sitting at more than 25%. And with the change in consumer behaviour that we’re seeing as a result of Covid-19, we expect this number to be larger than 25% over the coming years.”
Not only has technology become more prevalent over the years, but the business models of the leading tech companies have evolved. This view is supported by the largely ungeared balance sheets of many of the established tech giants. Microsoft, for example, has cash on the balance sheet of close to US$140 billion, Old Mutual said.
“To put that into perspective, several weeks back that was enough to buy the top three car manufacturers in Germany — Daimler, BMW and Volkswagen — without adding any additional debt on their balance sheet, which is quite remarkable.”
Tech companies today share two key attributes that will likely see them continuing to disrupt other sectors and lead market returns going forward. “In our view, Big Tech has both the agility and absorptive capacity, two qualities that have proven essential in seeing companies through difficult crises and growing above average,” said Mupunga.
Agility is a company’s ability to spot an opportunity and exploit it, according to Mupunga, while absorption shows a businesses ability to bounce back from setbacks thanks to its strong balance sheet or brand equity, for example.
From a valuation perspective, Mupunga is confident that talk of a tech bubble will remain just that. “Investors need to assess the prospects of the incumbent and emerging tech players by looking at their true value, rather than the hype,” Mupunga said.
“September’s market jitters should therefore remain just that, as history has shown that resilient companies that are quick to respond will endure.”
In terms of what could derail tech companies’ growth prospects, Mupunga pointed to regulation as the key risk for investors to watch. “While the risk of increased regulation is not new to tech companies, the push back from regulators and users is slowly gaining traction.
“There are several antitrust investigations in process and earlier this year, there was some concerted effort by a number of advertisers to boycott Facebook and YouTube due to the content on their platforms, although the boycotts did not last for long.”
While increased regulation is imminent, what remains unknown is the timing and exact nature that the regulation will take. “It is not a certainty that regulation will result in a lot of increased competition in the tech sector. In many instances, regulation favours incumbents and keeps out new entrants who are in weaker financial position,” Mupunga said.