What is a Technology Stock?
In a previous post, we briefly discussed lofty valuations for tech companies. However, simple attribution analysis will show that these richly valued companies have been responsible for much of the growth in the 10 year bull market. Market pundits and talking heads that show up on Reuters, CNBC and Bloomberg often go on screen and spout about how technology is due for a reversal. After all, what sector can go up consistently for so long.
But technology does have more room to run now and forever.
Looking as “technology” as a sector is convenient but truthfully a lazy generalization. How do we subsegment technology? Information technology/internet, semiconductors, hardware, software, networks, the cloud… in reality, what falls under the technology bucket ends up being anything that uses networks or a computer.
Everything is going to involve computers and networks going forward because we are in the 21st century. So as we continue to move towards more connectivity made easy via 5G networks, smarter devices in the internet of things and a better synthesis of all of the data available through these things driven by artificial intelligence what is the technology company of tomorrow? Everything will be a technology company.
All Stocks are Technology Stocks
Technology is a mislabelled – computers are not even a “new” thing any more and should not be seen as the forefront of bleeding edge tech. At some point in time the telegram was technology and car phones were technology.
Technology stocks are better seen as innovation stocks or stocks that are disruptive to an industry. Uber, Google and Amazon are technology companies – but are they necessarily lumped in the right bucket?
The gig economy and the sharing economy are hot topics in today’s venture capital circles. However, Uber, Airbnb, Lyft, Mobike, DoorDash and Redfin are not actually groundbreaking computer engineering. They are simple apps that have identified a market to disintermediate, generating producer and consumer surplus by doing so. They are creating value by removing business frictions and they are able to become incredibly profitable owing to the benefits of scale. What they are not doing is splitting the atom.
While secretaries and typewriters are jobs that have been extinguished, jobs that require high skilled labor are now in demand. This is simply progression and productivity growth, like how the Pony Express was replaced by the telegram and the telegram by the telephone and so on.
To put another way, should disruptors in Amazon (eCommerce/cloud), Google (advertising), Microsoft (office/cloud), Netflix (entertainment) and Facebook (advertising/communications) be seen as this Big Tech obelisk or are they just today’s iteration of the department store, print media, the physical office, Blockbuster and mail? “Technology” stocks will continue to rise because they will continue to offer services that people need and can be monetized. Yoox/Net-a-Porter uses technology but fundamentally it is just another medium to sell Louis Vuitton.
Having left investment banking a few years back, even then CEOs would always remind us – “we are not a bank, we are a technology company”. They were right – banks invest billions into technology every year to make sure that risk models were precise, processes became web based and easy to use, customers could bank more easily and databases served their purpose in becoming helpful rather than cumbersome. But we were also a bank – to say otherwise is just to get a good soundbite.
The honest answer is that all companies are technology companies. Even the local Dominos investing in upgrading payment platforms and new state-of-the-art ovens. Blackrock invests massively in their ALADDIN risk management platform but are an asset manager. Wealthfront does more or less the same thing but is an online platform aimed at millenials. They are classified as a technology company (or sometimes fintech, to be generous). Forget the buzzwords – good companies are good companies.
The Right Way to Look at Technology Stocks
As detailed, technology stocks as a sector should continue to outperform the market whether the bull market continues or we get the recession that the inverted yield curve implies. This is because this is a bet on innovation – and valuations, while higher than other sectors, are not looking anything like the tech bubble.
In fact, prominent market participants such as Jeff Gundlach from Doubleline have opined that certain subsectors such as the cloud (and the major players – Microsoft being singled out) will do well in a recession as companies looking for areas to trim the fat realize that they have to switch to cloud based servers and other offerings in order to save money.
The bigger takeaway in looking at technology stocks is looking at the subsectors. Semiconductors (Micron Technologies) are not enterprise resource management (Salesforce/Workday) is not internet (Expedia).
Also, given the valuation of Microsoft and Amazon’s cloud divisions, big data, data virtualization and certain SaaS (software as a service) companies – which are based on Price/Sales or Enterprise Value/Sales (since these corporates tend to have very low or non-existent debt they are more or less interchangeable) rather than earnings metrics, looking at P/E for technology as a whole cannot be meaningful. It is difficult to find a natural resources trading at 10x sales and if there is, unless there is a very obvious reason, no one should be investing in it.
These valuations, which will be discussed in a further post, are based on the addressable market share that it can eventually capture. Stocks are the present value of future earnings, and current earnings do not necessarily address that.