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Technology’s high valuations are being questioned

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Technology shares have been a major driver of global markets over the last eight years. The FANG (Facebook, Amazon, Netflix, Google: Alphabet) stocks have risen 4x more than the S&P 500 and now comprise 12% of the S&P 500’s market cap. Although we know that the technology sector adds significant value to global economic growth, an investor attitude of “must have at any price” has taken place, driving some valuations to irrational heights. The average FANG forward P/E (price: earnings) ratio is 51x versus the S&P’s 21x.

Two major justifications for these high valuations are:

  1. they are generally immune from major competition as far as the eye can see into the foreseeable future
  2. the effect of significant monetary stimulus, which has led to abnormally low interest rates, is supporting long-term valuations

We draw on an interesting article from Ninety-One addressing their concerns on three market darlings: Tesla, Apple, and Amazon.

Tesla – Investors assume it will have a dominant market in the future

Despite Tesla being a major leader of electric vehicle technology and that it is likely to have a large market share in the future, it will not be the only producer. Other vehicle manufacturers will participate strongly in this segment and the market will become quite fragmented. So, with Tesla’s current lack of profitability, high debt levels, and questions around volumes and future market share, the current market cap of $375bn is overdone.

Apple – More of a hardware company with a highly rated “services” valuation

Currently, 80% of Apple’s revenues are generated from premium-priced hardware sales and the remaining 20% from services-related business. To ensure more sustainable earnings, Apple needs to transition its business to earn a larger portion from services, which may be difficult to achieve. Therefore, its valuation is high as a predominately hardware-focused company.

Amazon – Vulnerable to regulation changes

There is significant regulatory risk that investors are not considering. A big issue is the possible forced separation of its first-party and third-party e-commerce businesses, which has arguably given Amazon an unfair advantage. It is expected that regulators around the world will be focusing more on tech in 2021 and investors need to consider which companies are more vulnerable to regulation changes.

Investonline’s conclusion

Technology shares are pricing in significant earnings growth over the long term amid intensifying competition, regulatory concerns, and eventual rising interest rates. Therefore, it is imperative that investment portfolios are well diversified and not concentrated in one asset class. Speak to one of our Portfolio Managers to assist you implement the appropriate strategy for you.

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