Tech boom: Party like it’s 1999?
Despite the surge in valuations, it is still possible to find quality tech investments, writes Anthony Fensom.
Mentioned: Nanosonics Ltd (NAN), Global X Morningstar Global Tech ETF (TECH), WiseTech Global Ltd (WTC), Xero Ltd (XRO)
Surging stock prices, sky-high valuations and enormous "stag" gains on initial public offerings. For the technology sector, is it 1999 all over again?
Despite a slight retreat recently, as of 18 September the tech-heavy US Nasdaq index had risen by 20 per cent since the start of 2020, taking its total increase over the past decade to more than 400 per cent.
The gains have been led by the famous FAANGs (Facebook, Amazon, Apple, Netflix and Google (now Alphabet)), which with a combined market capitalisation approaching $10 trillion have been worth as much as five times the value of Australia’s entire bourse.
Not to be outdone, Australia’s favoured tech companies have also shown sizzling returns. The S&P/ASX All Technology Index has risen by 14 per cent since its launch in February, boosted by gains in the "WAAAX" stocks (Wisetech (ASX: WTC), Afterpay (ASX: APT), Appen (ASX: APX), Altium (ASX: ALU) and Xero (XRO)).
Australia’s tech sector is also scrambling to follow Wall Street’s IPO boom, where tech stocks such as Snowflake have doubled in value on their first day’s trading. Around $10 billion worth of floats are scheduled on the Australian stock exchange before year-end, including fintech lenders Harmoney and Lendi and online retailer Adore Beauty.
The 2020 tech boom has drawn comparisons to the ill-fated dot-com boom and bust of 1999-2000, when an army of retail investors chased the next tech favourite, internet companies listed without any material revenue and analysts declared earnings irrelevant in the "new economy".
“There’s a lot of similarities from the tech bubble of 2000,” said Morningstar’s Ross MacMillan, senior analyst, manager research.
“Valuations for growth stocks are astronomical at the moment. And it’s across quite a few areas—you’ve got the fintechs, the BNPL [buy now, pay later] companies like Afterpay, healthcare stocks and biotechs like Nanosonics (ASX: NAN) and other tech stocks, whether software or hardware related.
“You look at the price/earnings ratios and many have no earnings, this is exactly what we saw in 2000, the multiples are huge. The 2000 tech bubble was driven by retail money and once again, discount stockbrokers like CommSec are getting overwhelmed by retail money, which is creating momentum in a lot of these stocks.”
He pointed to Australian market darlings of the dot-com boom such as Davnet, Melbourne IT and Sausage Software, which have disappeared or been restructured, as evidence of the need for caution among investors.
“There’s a lot of uncertainty about what’s going to occur globally and in Australia. At the moment we have record low interest rates, government is pumping a lot of stimulus into the economy, but what’s going to happen when the music stops? At this point a degree of caution is warranted.”
Different factors
Yet different factors are driving gains in the latest tech boom, according to technology analysts.
“The 2000 dot-com boom was indiscriminate. All the companies with a dot-com behind their name took off and most of them were loss-making,” said Morningstar equity analyst Brian Han.
“This time around the tech surge is driven by the [FAANGs] and they are highly profitable with sustainable competitive advantages.”
Nevertheless, Han noted that valuations were approaching peak dot-com territory.
“During the height of the boom the S&P 500 p/e [price/earnings] ratio peaked at over 30 times compared to around 26 times now … At some point valuation does matter and therein lies the risk in chasing these high-flying tech stocks,” he said.
However, Morningstar equity research strategist, Gareth James points to other factors driving recent tech gains.
“The first thing to bear in mind is the notion of technology stocks is a problematic concept—you have companies grouped together which often don’t have anything in common,” James said.
“The second thing is you have a situation around the world where currencies are being devalued and we’re seeing huge asset price inflation, together with economic weakness. So if you’ve got an asset that isn’t being impacted by economic weakness then you’re going to see the asset price increase significantly."
A historically low level of “risk-free” interest rates driven by ultra-loose monetary policy may have increased the “sustainable” level of valuations, according to Capital Economics.
The London-based consultancy also points to the absence of other "bubble" factors. The dot-com boom saw a surge in margin lending and trading volumes together with unbridled optimism over economic prospects—factors which are largely absent in 2020.
It also says the dominance of a few large firms in the S&P 500 reflects increased concentration in the US corporate sector since the dot-com era, with social distancing due to the covid-19 pandemic benefitting the tech giants’ business models.
Where can you find value?
Amid the surge in tech valuations, how can Australian investors find value?
While admitting that “the tech stocks we cover in Australia are overvalued at the moment,” James suggests it is still possible to find quality tech investments, particularly overseas.
“Morningstar has an ETF [exchange-traded fund] called TECH [ETFS Morningstar Global Technology ETF] that provides exposure to global tech companies which you can buy on the ASX. What we hope to do over the long term is generate investments where you can obtain a good total return, as we have visibility into the profits these businesses can generate,” he said.
Other ETFs providing tech exposure include the BetaShares S&P/ASX Australian Technology ETF (ASX: ATEC), which tracks the S&P/ASX All Technology Index, or the ETFS FANG+ ETF (ASX: FANG), which provides exposure to US technology leaders including Apple and Tesla. Alternatively, broader exposure is available via ETFs tracking the tech-heavy US Nasdaq index, such as the BetaShares NASDAQ 100 ETF (ASX: NDQ).
Investors concerned by expensive valuations might consider an even bigger risk of obsolescence, according to Ark Investment Management’s research director Brett Winton.
“What I would worry about as an investor is what is my exposure to fixed assets that are potentially encumbered by debt that are going to be disrupted by technology. Am I appropriately exposed to technology to protect myself against that risk?” Winton warns.
In the US, Winton points to industries such as railway transportation, which is at risk of being disrupted by autonomous electric vehicle trucks, or the retail banking industry that faces competition from the growth of digital wallets.
“Every sector is being infiltrated by innovation in a profound way. I don’t know if it will happen this year or in six months, but over a medium-term time horizon, everything will be innovation-based or it will die,” he said.
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