by Gerrit Smit, head of equity management at Stonehage Fleming
With global technology stocks enjoying strong returns, the big question is whether another tech bubble is brewing? While some market analysts say ‘yes’, I have a different view.
The returns being produced in the technology sector are based on real organic growth that is occurring right now; not on the prospect of future growth, which was the case during the dot.com bubble of 1997 to 2001.
Many of the major technology businesses are creating significant free cash flow currently, which is funnelled to shareholders through successful reinvestment or through dividends. This is an important cornerstone of prudent, successful investing. Without free cash flow, shareholders have more uncertainty of future returns.
This is an important cornerstone of prudent, successful investing. Without free cash flow, shareholders have more uncertainty of future returns.
During the dot.com bubble the free cash flow yield on the S&P 500 technology sector was less than 2%. Currently that figure is 4.9%, a ratio of more than double. Furthermore, the 12 month forward P/E multiple in the dot.com bubble era was around 40, whereas now it is 19. In both
In both instances, the valuations are half as expensive now as they were then.
In addition to strong free cash flow, I see strong, sustainable, organic growth potential in many technology stocks, notably large-cap counters. This is the second reason that Stonehage Fleming’s Global Best Ideas Equity Fund, which I manage, is nearly 30% invested in major cash generating technology companies.
In the current technology world, the focus is on big data and getting information as fast as possible to as many as possible all over the world through smart mobile devices. While Apple recently launched its new smartphone with a price tag of $999, both India and China are producing models with comparable technology priced around $100. This is making mobile technology and its many benefits accessible to more individuals than ever before, creating a sustainable growth path for well-managed companies that distribute their products through mobile technology.
In the technology sector, the clear way to monitor whether a company remains to be relevant is to follow its organic revenue growth. If this doesn’t come through consistently, it implies that their technology is falling out of favour and the business may be in process of becoming extinct.
In terms of individual technology stocks, the fund has positions in, Visa, Tencent, Alphabet, Accenture and PayPal. Tencent is one of the world’s most successful technology companies.
Using the metric of organic growth as a benchmark, Tencent reported in their last earnings announcement that their revenue line grew by over 50%. In addition, their compounded free cash flow growth over the past four years was over 33% per annum.
Tencent’s strength lies in having a number of different earnings drivers. Its social network business WeChat alone has over 900 million active users. Both a social media and messaging app, WeChat is also used for mobile e-commerce, payments, ordering food, taxis and more. Furthermore, Tencent has a stake in JD.com, China’s version of Amazon, and in Didi, the country’s version of Uber. Importantly, we are also comfortable with Tencent’s overall corporate governance.
Turning to Visa, this technology giant supplies the platform on which all Visa transactions globally occur. Its growth potential is based on the fact that payments, whether consumer, corporate or institutional, occur more and more online. The mushrooming of e-commerce is adding further fuel to the company’s growth potential.
Alphabet is another outstanding business. As the holding company of Google, Android and YouTube, it is also very active in AI, driverless cars and satellite communications; Alphabet’s free cash flow growth has exceeded 17% per annum over the last four years.
Recently, assets under management (AUM) in the Stonehage Fleming Global Best Ideas Equity Fund passed the US$650 million mark. The fund, which attracts investments from private, professional and institutional investors has returned 47.2%* over the last four years, compared to MSCI World All Countries Index of 39.0%.
I run this concentrated, high conviction portfolio of 24 stocks that are chosen for their sustainable growth potential, strong management, strategic competitive edge and attractive valuation. The portfolio has very low turnover: over the past 12 months Gerrit has only sold two positions and initiated one.
In addition to the high weighting in technology stocks, other investments include some of the world’s best-known companies such as Nestle, Estée Lauder and PepsiCo where there is confidence in the sustainability of indefinite growth rather than volatile cyclical growth.
*Source: Stonehage Fleming Investment Management (SFIM), figures to 16 August 2017 (net of fees) Share Class B