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What could the technology sector offer potential investors?

It’s been a tumultuous few weeks for the US tech giants but can we expect growth to continue?

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Topic: Investing

Alex: So, Andrew, it has been a really big year for tech stocks. We’ve seen Apple hit a record market cap. At the same time, we’ve seen Facebook fall 20%. Is it something we should be worried about? Are they getting a bit volatile?

Andrew: Well it’s only recently that the fortunes of these companies have diverged a little bit, to be perfectly honest. Over the last year or two, these have been tremendous stocks, trading in a consistent and impressive way. But you’re absolutely right, the last few days we’ve seen a couple of companies disappoint, and admittedly quite lofty expectations. But the real truth is that none of these stories have deteriorated fundamentally, they’re all tremendously strong companies with great business models. And as the world moves forward, I think there’s so much innovation and so much disruption in the world, most of these companies are still tremendously well placed.

Alex: So, you mentioned there are disruptors in the marketplace? So, if we move on to say Netflix. So, Netflix recently disappointed slightly, but it has obviously been a stellar performer over the years? Do you think these tech stocks are well positioned as disruptors in most markets?

Andrew: You say tech stocks, but Netflix is caught up in this, it’s not a true technology company. And one thing to really remember is, these big companies are addressing quite different markets. So, media is what Netflix do, obviously Apple have the iPhone, Amazon are reinventing retail, so they’re not really true technology companies, what they are are true growth companies, and the diversity of opportunity that they have, gives me great confidence for the long term future for the vast majority of these names.

Alex: So, you mentioned there, growth companies? Do we think that maybe investors are placing too much emphasis on the growth of these companies, and they may disappoint if they don’t live up to expectations?

Andrew: I think that’s a great question. As I said, individually the stories are tremendously powerful for the long term, but at times expectations just get ahead of reality, and it’s very, very hard sometimes for these companies that are growing tremendously fast, and producing, in isolation, brilliant sets of numbers, to actually meet those lofty expectations. And I think that’s what we’re seeing a little bit in the last few weeks as these companies have reported earnings.

Alex: And Apple has obviously got a lot to smile about? It’s the first one trillion dollar company?

Andrew: Yes. A trillion dollars is just a number, to be perfectly honest. It’s a headline grabber, but it’s just a number. I think what it does reflect is the tremendous power of the Apple business model. Historically it has been all about the iPhone, and iPhone sales. But the market is starting to get the sense that there’s far more to Apple than just the iPhone and moving into services. So, think about Apple Pay, think about the watch, as well as their normal hardware, like obviously the Mac, and the iPad, and the phone. And so what Apple are building is a global ecosystem. They have consumers locked in, and they have a massive in store base which is proving more and more profitable, and as they diversify away from the iPhone more and more, the company continue to grow at a very, very high level. And it’s actually still one of the cheapest stocks that we cover in the large cap technology group, so it’s a number, but it’s good fun.

Alexyou then focus on Facebook maybe for a second, we’ve seen them disappoint, and they’ve obviously come under quite heavy pressure from the US government in terms of regulation, or potential regulation?

Andrew: Yes, I think absolutely. Government regulation is our biggest fear for some of these hugely successful technology stocks, because obviously they dominate the industries that they’re in, and quite rightly governments are starting to be concerned about the impact, especially of social media, of these large companies. Fundamentally they’re great, the businesses are tremendously strong, but yes, if there is a worry, it is going to be government interference, and we’ve seen that recently with the Cambridge Analytica debacle over here, in the UK, that spread to the US elections. And quite rightly, regulators both in the US and here in Europe are starting to raise these concerns to market.

Alex: So, another concern that maybe investors have, is that parts of these companies don’t make any money currently. There’s lots of different parts that go into Facebook. So, you’ve got WhatsApp, and then the Facebook core business? Should investors be concerned that maybe there are parts that are just dragging back the companies rather than actually contributing to their growth?

Andrew: I don’t think so at all. I think the beauty of these companies is they identify huge, huge markets that will be profitable over time. They’re building a ridiculously fantastic service that the customers love. You can use Amazon as an example. Amazon made very little money in retail the first few years, WhatsApp as you mentioned makes very, very little money at the moment, for Facebook as well. And that is the models that will build it, and they will come and get the consumers excited, get them in an ecosystem that we all love, like the Apple ecosystem. And over time, the profitability will come, but these companies are not driven by profitability in the short term, which I think is great.

Alex: And so Amazon is always seen as a big disruptor in markets. So, we’ve seen it move into say healthcare, and we’ve seen it move into physical stores? Do we think maybe it’s spreading itself too thin, or do you think it can operate in all of these different markets?

Andrew: It certainly can’t operate in all of them, and there’s many rumours about a new market that Amazon is going to go into. But what they do focus on is markets that they can win, that they can grow huge new revenue streams, and importantly where they can go where their brand is trusted. And this is the same for Apple, it’s the same for Amazon, it’s the same for Google, these are unusually powerful brands that the customer has empathy with, and they’re willing to trust them as they move into new markets. And the customer really ends up getting a lot of the value that Amazon or these other companies create.

So, they will continue to spread, they have the logistics, the firepower, the balance sheet, the brand to do whatever they want, so that doesn’t concern me yet that they’re spreading themselves too thinly at all.

Alex: So, the big news this year has been trade wars, it has affected the markets around the world. Tech is also seen as a bit of a safe haven sometimes. Do we think this is true? Does it still hold true?

Andrew: Well technology is not immune to trade war, or the end of globalisation fears. Certain parts of technology are actually quite cyclical as we would call it. So, things like computers, and servers, and semiconductor chips, they can be a cyclical business as any in the market. But when we say safe haven, we are really talking about some of the names we’ve mentioned before, so it’s just Amazon and Netflix and Google, they offer software, they offer services. And they certainly are more immune I think to a global trade cycle turning down. They offer such tremendous growth, and a really strong generation of cashflow and profits, that that kind of growth can offset the cyclical weakness that trade wars would bring to other parts of the market.

And another point to make is that these are not single product companies, you know? Amazon is not just a retailer anymore, Apple is not just an iPhone company, Google is just not about search. These have platform businesses that are global, that are growing individually very, very strongly. And so that gives us lots of comfort that although tech cannot be completely immune, certain parts of it do offer investors certainly a safe haven in tough times.

Alex: And if we draw it back to say 2000, tech was obviously in a bit of a bubble, and went through a crash, but now we’re saying it’s a safe haven? Do we think they still marry up?

Andrew: I think certainly times are different. If you go back to previous times when technology shares really were under pressure, they tended to be companies that were focusing on one particular area, single product companies, whether it be semiconductors, or PCs, or brand new internet companies that were coming to the market for the first time. They actually had very little in terms of earnings power, they were afforded very, very expensive valuations by investors, but they didn’t have what today’s technology companies offer which is really strong balance sheets, growing and safe dividends in many circumstances, and the generation of lots and lots of cashflow which gives us as investors protection, and gives the companies options to reinvest in their business.

So, in terms of sentiment, is the group over-owned? Absolutely. But in terms of the fundamentals, are they much improved compared to previous crashes? Absolutely.

Alex: So, we’ve seen some of these technology stocks fall quite hard so far this year? Do we think investors should be taking advantage of this, and piling in?

Andrew: Well, we never say ‘piling in’ in the investment world to any particular theme at any particular time, what we try and do is invest sensibly for the long term. But yes, absolutely, we should be looking to take advantage of any serious correction here. There’s so much innovation, and so much disruption in the world. There’s probably more disruption and innovation than I have seen at any time in my career. There has to be opportunities, and we are very committed to these long term themes that we are talking about today. So, in the short term, sentiment can be very, very aggressive in the sector, at times the corrections can be very significant, but the bottom line is, these companies are going to grow tremendously impressively for the next several years. And so if you can find an actively managed fund to invest in as a first port of call, to diversify your risk, then that’s great.

But also our clients have real conviction in themes that are important to them in their lives, renewables, or solar, or electric vehicles, there are absolutely some really interesting direct equity investments, that they could even be looking to add to their portfolios.

If you enjoyed this piece, why not watch our August 2018 Market update?

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