Where To Find Value In Global Tech Stocks

By Roger Montgomery, Montgomery Investment Management

This bull market has featured stellar performances from a small group of technology stocks, like Apple, Facebook and Netflix. Indeed, we've not before seen so much capital concentrated in a single sector. Despite the lofty valuations of most of these businesses, we continue to see some excellent investment opportunities.

Meanwhile, the emerging perception of increased regulatory risk for FAANG (Facebook, Apple, Amazon, Netflix and Google) stocks has not only capped prices, it has served as an important reminder that excess profitability cannot be extended indefinitely and come up against an opposite force. That may be competition, but it may also take the form of societal rejection or regulatory backlash.

Listed among the ten most valuable companies in the world, Google dominates search with a 90 per cent share, Facebook commands 88 per cent of social media traffic in the US and by some accounts, nearly half of Americans obtain their news from Facebook. By 2016, the share of online US consumers bypassing search engines in preference for Amazon was 55 per cent, and the biggest Chinese tech companies including Tencent, and Alibaba command similar or even larger shares.

As recently as February, the NSYE FANG+ Index was collectively valued at multiples of three times that of the broader market. The divergence is even greater than during the peak of the tech bubble in 2000. While the S&P500 has advanced a phenomenal 331 per cent in the nine years since 2009, Amazon is up over 2,100 per cent, Apple 1,100 per cent, Netflix 5,300 per cent and Google is up 586 per cent. Adding Facebook, Microsoft and Nvidia to that list and eight stocks now account for over 15 per cent of the entire S&P500 and just shy of 50 per cent of the NSDAQ-100 index.

While much of the commentary during the recent technology boom lauded the superiority of everything from the disruptive asset-sharing models of Uber and Airbnb to 3D printing, digital advertising, electric vehicles and the autonomous fourth industrial revolution, the underlying business models of many operators remain unviable without the support of private equity injections at increasing valuations. Where this is the case, investors need to be especially cautious. By way of example, Uber continues to be loss-making despite valuations of about $US51 billion.

Meanwhile, Amazon is being openly attacked by the US President on Twitter, and Airbnb hosts are being levied with conditions that limit short term leasing.

It was inevitable that as these companies gained unprecedented power and influence there would be a societal or regulatory response.

In the US, the Democrats, who were arguably defeated at the last election because they cosied up to big business, are returning to their roots with an election blueprint and new economic agenda ahead of the November midterms called 'A Better Deal'. The section of 'A Better Deal' entitled "Cracking Down on Corporate Monopolies and the Abuse of Economic and Political Power" is focused entirely on antitrust enforcement and merger law, the most important but arguably weakest component of America's competition policy. Meanwhile, in a decision with far-reaching consequences for many tech companies, Europe's highest court, the Luxembourg-based European Court of Justice responded to a complaint by a Barcelona taxi drivers association, that wanted to prevent Uber from setting up in the city. The court agreed that Uber drivers should be regulated like a transport company and not a technology service.

In Europe, a set of sweeping reforms under the banner of the 'General Data Protection Regulation' (GDPR) were established in May. Under the GDPR, European residents have control over how their digital data is used and arranged, including the "right to be forgotten". They have the power to remove or update data on company servers, be able to request the data and port it to another company.

Let's take a look at a couple tech stocks.

Netflix

Netflix hit a record 117.6 million subscribers in the last quarter of 2017. This was thanks to the addition of 1.9 million US and 6.4 million international subscribers. International subscribers grew 11 per cent in the fourth quarter from the third quarter and US subscribers grew at just under 4 per cent. In 2017, the number of international Netflix subscribers surpassed US domestic subscribers.

While the company is expected to earn between US$1.88 and US$3.27 the shares are trading at between 74 and 153 times earnings and Disney announced in November 2017 that its own two largest franchises, Star Wars and Marvel, will move exclusively to Disney's own streaming service from 2019. Fourteen Disney films have grossed more than $1 billion worldwide, including two Star Wars releases and four Marvel movies.

With 55 million Netflix subscribers compared to 94 million pay TV subscribers in the U.S. and a steeper growth trajectory, 40 of the 56 analysts covering Netflix have a Buy rating, and only 2 have a Sell rating. We believe the most expensive tech names are at the greatest risk of disappointment.

51job

Founded in 1998 and listed in the US, 51job Inc. is headquartered in Shanghai, China. The company provides human resource outsourcing and consulting, as well as recruitment solutions, training and assessment.

The company has a long runway of revenue and earnings growth ahead as more employers migrate to online advertising for jobs. Meanwhile the company has put through a range of price increases of up to 45 per cent. Previously, and for six years, a 1-month membership with 20 job listings would cost an advertiser 600RMB (A$123). As of 1 February, the price increased to between 800RMB and 1000 RMB (A$164-A$205). These price increases carry no incremental costs which will boost margins beyond the strong increases of 2.5 per cent year-on-year in the fourth quarter of 2017.

The Montgomery Global Funds own shares in 51job, Facebook, Google and Apple.

 

Roger Montgomery
Roger is the Founder and Chief Investment Officer of Montgomery Investment Management. Roger brings more than two decades of investment and financial market experience, knowledge and relationships to bear in his role as Chief Investment Officer. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

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