Are technology stocks broken?
Not only did the Covid pandemic bring profound harm and disruption across the planet, but it also catalysed a massive shift in consumption and social interaction. Everything that was previously done in person has been challenged by an online alternative, and this has propelled technology stocks in general, and FAANG* stocks in particular, to new heights, due to their advantages in addressing this fundamental shift.
As a result, the revenues and profits of these tech heavyweights dramatically accelerated as Covid spread, nearly always at the expense of their off-line competitors. The stock prices of these companies followed the logic of their fundamental change, with the losers from stay-at-home orders suffering and the winners reaching new heights. And then came the end of the summer 2020. For those stay-at-home losers, Covid-related pressure on earnings abated, and for stay-at-home winners, the Covid-related acceleration ceased. In turn, global-equity markets, believing the worst of the pandemic was behind us, turned their attention to those companies that had been depressed by Covid, expecting their businesses to recover as the world reopened for business. The assumption that the pandemic would have a definitive end remained an undercurrent hroughout.
With this return to normal came the assumption that the opportunity for gain was far greater when investing in the high-quality companies that had been stay-at-home losers and whose earnings had not yet fully recovered, while the stay-at-home winners had run their course.
And this belief played out in markets. Those companies that had done welluntil the end of last summer suffered and the enthusiasm for tech stocks all but disappeared as investors piled into value stocks. But nearly one year later, is this still true today? And if so, are tech stocks broken for good?
Simply answered, no, and for the simple reason of growth. Since late august 2020, the S&P 500 Value index has gone up by 25% versus 15% for FAANG stocks.
At the same time, the earnings per share of the S&P500 Value index has gone up by 29% over the period versus 42% for the FAANGs. So while the FAANG stocks gained less over the last 10 months, they also became the better value in terms of amount of earnings per price paid (priceto-earnings ratio) than value-style stocks, and this trend is unsustainable. Unless profit growth among the FAANGs slows down significantly, their stocks should eventually catch up with and overtake value stocks.
We are confident that tech stocks do have more room to run indeed and that the ascendancy of value stocks will ultimately be limited by slower revenue growth among value-style companies.
Technology company profit growth – particularly among the FAANGs - will likely slow down somewhat and revert towards pre-Covid trends. But their structurally faster and durable growth potential has been clearly established.
In the last 13 years, the profits of the MSCI World index have grown by an average of 2% per year and are now around 45% higher than they were in July 2008. Over that same time period, profit growth for the MSCI World Technology index, was more than quadruple that rate at 9% per annum, and current profit growth is nearly 350% higher than in the summer of 2008.
As long as innovation continues to thrive and assuming that we will not be giving up our smart phones to return to writing letters anytime soon, tech growth and more specifically, tech earnings growth, should be well supported to continue. Furthermore, this profit growth should carry on propelling tech stocks upward. As the Covid lockdown effects – both negative and positive – on non-tech companies abate, the earningsgrowth drivers of these companies will likely also be less favourable than those of tech companies, as they were before the pandemic.
We believe that technology will be a long-term, sustainable contributor to the solutions needed to make the world a better place. That idea is core to our approach to company selection and how we advise our clients regarding their own portfolio decisions. Indeed, investing in technology is an investment in the future.
*FAANG stands for Facebook, Apple, Amazon, Netflix and Google