Investing in the tech giants

With companies like Facebook and Apple dominating our daily lives, they also deserve a considered place in our portfolios

Chinese and American technology giants are fundamentally changing the way we go about our daily lives. But they’re also changing global commerce, and this is rewriting the playbook when it comes to the way investors view them. Technology titans can be split into two camps: the American FAANGs (Facebook, Amazon, Apple, Netflix and Alphabet, which owns Google) and the Chinese BATs (Baidu, Alibaba and Tencent). Microsoft should also be in there, as the world’s most valuable company, but “M” doesn’t seem to lend itself to the acronym, so it misses out. Electric vehicle maker Tesla also deserves a special mention.

The FAANG companies should be familiar to readers of Money. The BATs are less known. Baidu is a search engine, like Google, and it is also heavily invested in a range of internet-related products. Alibaba is a retail and ecommerce business, like Amazon. Tencent is another conglomerate of varied internet-related services, but is most notable as the world’s largest video game company.

To give some idea of the scale of these companies, the FAANGs have a combined market capitalisation of more than $US5 trillion ($7 trillion) at the time of writing. That’s more than three and a half times Australia’s entire gross domestic product (GDP) for 2019.

They are also popular with investors, meaning they’re expensive. Many of these companies have share price-earnings (PE) ratios, at times, in triple digits. That compares with an average of 30 for the whole of the NASDAQ, the stockmarket where the FAANGs are listed.

Same but different

The FAANGs and BATs share many similarities. Both leverage technology and massive market reach.

According to Alex Pollak, chief investment officer at Loftus Peak, a fund manager who invests exclusively in disruptive companies, the core quality that binds these companies together is the networks they run on. The communication industry’s Metcalfe’s law and the network effect holds that the number of transactions is exponentially greater the more people there are on a network.

“With every potential connection, there’s essentially someone tolling that connection,” says Pollak.

That could be through advertising as in the case of Facebook, connecting sellers and buyers in the case of Amazon and Alibaba or connecting gamers in the case of Tencent. This is the reason these companies are able to harvest so much value. They’re also products of rapid advances in telecommunication technology.

“If you look at the whole way online is digitising commerce, it’s all about connections combined with fast broadband,” says Pollak.

Indeed many of these companies simply couldn’t exist were it not for the huge advances we’ve seen in broadband capacity. Watching Netflix or Amazon Prime movies in high definition would not be possible with the dial-up internet of old.

Where they fit in

While these companies share the same space when discussing disruption in the 21st century, they still provide vastly different products and services.

“There is competition amongst them, but they do each command their own segments of the market,” points out Kanish Chugh, from ETF Securities. “When we talk about these companies, we call them tech – but on a sector basis only Apple is a tech company. All the others are either consumer discretionary or media and communications.”

While these new age companies can be misdefined, some of them seem unable to fit a definition at all.

“What really is Google?” asks Chugh. “Is it a tech stock, is it a media and communication stock, or is it an infrastructure stock. Where does it actually fit?”

Chugh prefers to view these companies as infrastructure players, a nod to their cornerstone role in society. While roads have moved goods and services in the past, and still will, broadband networks will do the same in parallel in the future.

“They combine physical or information distribution and artificial intelligence,” says Chugh.

The American FAANGs and the Chinese BATs do admittedly serve different markets, but this difference is shrinking.

The FAANGs have a truly global target market. You’d be hard-pressed to find any place in the developed world that isn’t also populated by an Apple product or receiving an Amazon package.

The BATs, by contrast, have been primarily reliant on the domestic Chinese market.

“Companies will always gravitate towards their home market,” says Chugh. “China already has an enormous consumer market so it’s not a bad place to start and grow. Now the BATs are expanding outside China.

“The same took place with the FAANGs. They became entrenched in developed markets before moving into emerging markets.”

Granted, there has been pushback against Huawei’s attempt to provide 5G networks in western countries, but it’s predominantly a hardware company whose products reportedly pose a security, and therefore

While roads have moved goods and services in the past, broadband networks will do the same in the future

geopolitical, threat. And the ongoing trade tensions between the US and China make it increasingly difficult for companies in one to do business in the other.

The new blue chips

The tectonic societal shift these companies represent, combined with their novel business models, is leading investors to question the way they perceive and value them.

A traditional PE ratio may not work for companies like these that are disrupting industries and committed to reinvesting their revenue.

This is vastly different from what we in Australia have traditionally thought of as blue chip: banks that pay dividends.

But Chugh believes the tech giants better represent what a blue chip truly is: reliable earnings and future growth potential. And if “cash is king”, then they’re set to be long-reigning monarchs, with combined cash pools in the hundreds of billions.

“We need to rethink how we value these companies,” he says. “Maybe we look at total return, and also look at the places where we get yield, because we can’t get yield to the same extent from fixed income these days.”

Admittedly, these companies can exhibit short-term volatility. But their growth potential is without question, and if any companies are future proofed these surely come close.

“You need to ask: are you buying into the stock price or the future of the world – the thematic play that ‘I fundamentally believe in this disruption’.”

Not all investment experts are convinced the meteoric rise of the tech giants will continue unabated. A report by Aoris Investment Management pushes back at the common view that these companies have won their respective “winner takes all” markets.

It suggests they face maturing core markets and increasing competition, often from each other. “Their incremental capital investments are going into areas where they are competitively weak and returns are unlikely to be as juicy as those they have enjoyed from their core business over the last decade,” says the report.

Repeating these successes on such a scale is simply very unlikely, they argue, and attempting to do so can be harmful to investors looking for growth. “The frontier markets that the FAANGs are entering create a sense of excitement and are full of potential, but the cost of participation is high and the probability of success for any one participant is low,” says the investment manager.

Add to this the “hot hand fallacy” that plagues many investors – the belief that a good thing in the past increases the likelihood it will be a good thing in the future.

“It makes us think that Amazon will dominate every market it enters; that everything Apple touches will turn to gold; and that the algorithms that have created online search and targeted online advertising will solve trillion-dollar problems in industries such as healthcare, transportation, education and law enforcement.”

How to invest

Gaining direct exposure is possible through broking platforms such as CommSec and Nabtrade. The FAANG stock codes are FB, AAPL, AMZN, NFLX and GOOG, while the BAT stocks are BIDU, BABA and TCEHY. All are listed on the NASDAQ apart from Tencent, which is listed on the Hong Kong exchange.

Another option is to hold shares through an exchange traded fund (ETF). The BetaShares NASDAQ 100 ETF tracks the performance of the NASDAQ 100 Index. That does sweep up all NASDAQ-listed companies, weighted by market capitalisation, but the FAANGs make up more than a third of the pie.

ETF Securities offer its FANG+ ETF. Despite the name, this one includes both FAANG and BAT companies by tracking the FANG+ index on the New York Stock Exchange.

In the managed funds space, there’s the Loftus Peak Global Disruption Fund, which holds Amazon, Google, Qualcomm and Alibaba, among others.

The Magellan Global Trust (ASX: MGG) is a listed investment trust with exposure to many of the tech companies, such as Alibaba, Facebook, Google, Tencent and Microsoft.

If investing in the local market is more your thing, then the WAAAX stocks (WiseTech, Afterpay, Appen, Altium and Xero) represent equivalent, albeit smaller, disruption. The BetaShares Aussie Tech ETF (ASX: ATEC) provides an easy way to gain exposure. Managed funds include Fidelity Future Leaders, Colonial First State Smaller Companies, Pengana Emerging Companies and Hyperion Small Growth Companies.