Cover story – The tech bubble
$600bn (£429bn) in the case of the clean energy company would amount to selling its cars for $1.25m (£895,000) each, much higher than the £40,000 you can pick one up for. And while Apple continues to remain a popular household brand, its market cap of around $2trn (£1.43trn) is greater than the value of all the listed companies trading in London combined. What these diverse tech giants have in common is a perceived status as innovators, combined with a belief that they might be more resilient to structural changes in the global economy; a trend which has been accelerated by the Covid pandemic, says Daniel Booth, chief investment officer at Border to Coast. “The relative valuations of growth versus value are quite extreme today. At the beginning of the year we were at the 95th percentile, according to Research Affiliates, and that means the ratio of more expensive growth stocks to cheaper value stocks was more expensive than 95% of the history, and we’re now at a 100%. “So, the divergence between the expensive stocks and cheap stocks is at record levels,” he adds. “That is partly because of the Covid market environment that has benefited online large- cap tech companies and been disadvantageous for cyclical, lev- eraged value sectors.”
Back to the 90s It is no wonder then, that comparisons to the tech bubble in the early 2000s are mounting. Now, just like then, markets are awash with cash thanks to loose monetary policy and investors piling into growth stocks, although the volume of money in cir- culation has increased dramatically. There is also a growing speculation on tech IPOs, from DoorDash (a food delivery ser- vice) to Airbnb, which are eerily reminiscent of the initial surge in demand for firms like
pets.com in the 1990s. Investors in tech stocks today argue that traditional metrics of valuing stocks, such as earnings per share, are of little use for the tech sector, because they do not accommodate for the strong growth rate and the different markets tech stocks serve. One sceptic is Kevin Wesbroom, a professional trustee at Capi- tal Cranfield.
“I struggle with that argument. In the year 2000, people were saying that you cannot value e-commerce businesses using tra- ditional valuation techniques because they work in a different way. “For people selling cat food with no business model, you need a different approach. At one level that is true and applies today as well, if you take, for example, the rise of online retailers like Amazon. “I buy into that argument to a limited extent but not to the extent that it would be fully justified,” he adds. “For what it is worth, Tesla probably is overvalued.” Wesbroom admits that traditional metrics such as price/earn-
22 | portfolio institutional | March 2021 | issue 101
ings or earnings per share for measuring value have their limits. “You have to be broader in your thinking, you are backing a dis- ruptor in the broadest sense of the word. But does that make it right that Tesla is currently valued more than the nine biggest car manufacturers in the world? That is a huge premium on disruption you are putting out there and the nature of disrup- tion and gifted individuals is that they do not get it right all the time,” he adds. Nevertheless, there are still significant differences to the situa- tion two decades ago. On the plus side, Apple, Microsoft and Alphabet are more established than the ambitious e-commerce retailers of the 1990s. Today’s tech giants typically rely on a subscription-based earnings model, which has helped them book significant profits in the past year. Simon Pilcher, USS Investment Management’s chief execu- tive, argues that any comparison to the dotcom bubble is mis- leading and cautions investors against opting out of all tech exposure. Instead, he believes the merits of tech stocks should be analysed on a case-by-case basis. “We’re not explicitly saying that those stocks are to be avoided. Amazon, for instance, is likely to continue to benefit structur- ally from this shift away from physical retailing. And the ability of that business to leverage its dominant position is impressive. “But that is also the area where at some point one would have concerns about whether regulators might start getting con- cerned about companies exploiting a dominant position,” he adds.
Heavy exposure On the downside, the surge in their market cap means that today’s tech giants have also become major index constituents. If Tesla is included, the six largest tech firms now account for around half of the Nasdaq 100’s value and about a fifth of the S&P500.
This in turn means that they feature prominently in the portfo- lios of many institutional investors who have opted for passive exposure to developed market growth stocks, which is especially the case for defined contribution (DC) funds. The top 10 share- holdings for Nest’s 2040 retirement fund are almost exclusively tech giants, accounting for more than 12% of the fund’s overall equity investments. They also cover the lion share of Nest’s higher risk fund, which has more than 70% of its portfolio exposed to equities, of which some 13% is with the six largest tech giants. Nest is not the only UK scheme heavy exposed to the tech sec- tor. They also feature heavily in Smart Pension’s default funds and are the top holdings for The People’s Pension’s growth-ori- ented funds.
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