The Daily Telegraph - Saturday - Money
The key risks facing each of the tech giants
Despite monster share price gains over the past few years, investors are still piling into American technology firms. These are now by far the largest companies on earth. Last week Apple became the first US stock to reach a $1 trillion market value, with Amazon and Google not far behind.
The positive case for these tech giants is well known, and many investors think they can keep delivering. A global survey carried out by Bank of America Merrill Lynch found that professional fund managers had ranked Facebook, Amazon, Apple, Netflix and Google (the “Faang” stocks) as the most “crowded” – popular – investments worldwide for six straight months.
Estelle Menard, who manages the CPR Global Disruptive Opportunities fund, said: “They are winner companies that have disrupted and continue to disrupt legacy industries. Their long-term growth prospects come mainly from their ability to dominate their markets.”
But the Faangs face significant risks, and the weight of expectation means that when those risks rear their head the reaction is dramatic.
Last month Facebook announced that it had missed revenue expectations and that user growth was slowing, warning that both trends could continue. The share price fell by more than 20pc, wiping more than $100bn (£77.5bn) off its value.
Chris Beauchamp, chief market analyst at trading service IG, said: “These stocks face the tyranny of high expectations. People have piled in and expect them to do well quarter after quarter. They have all cornered their markets and have solid margins, but inevitably take it hard when they don’t meet expectations.”
Before you invest, here are the key risks facing each of the Faangs.
Facebook set out some of the problems it faced in its recent earnings report: slowing revenue growth, rising costs following recent scandals, a failure to add users in America and a loss of users in Europe – markets where it makes much of its profit.
Mr Beauchamp said: “Young people are turning away from Facebook in favour of other platforms. Most of Facebook’s profits come from selling adverts in the wealthiest markets – if those are weaker, can new markets compensate for that?”
He added that despite weathering the Cambridge Analytica scandal, where Facebook users’ data was misused, there was still a potential threat from regulation. The remedies taken, and the need for increased spending on security, are potentially costly.
Amazon has disrupted or is attempting to disrupt a number of industries: high street retail, food delivery, consumer technology, music streaming, cloud computing and more.
“The driver of Amazon over the past few years has been its move into o cloud computing – it’s because of that cash engine ne that it has been able to invest nvest in everything else,” said Mr Beauchamp. He added dded that Google and Microsoft osoft were major rivals to that at part of its business.
There is also a risk from regulators. “The American government could d say this is ridiculous – it’s crowding out every market and taking on one industry at a time. It’s an apocalyptic scenario, but it is a possibility,” Beauchamp said.
Apple is undeniably reliant on the iPhone, which accounts for two thirds of its revenues. “Apple is an iPhone machine, but it doesn’t have the same ability to produce blockbuster numbers just by revealing a new model,” said Mr Beauchamp. “For companies built on the foundation of excellent further growth, revising expectations down d is a problem.”
The firm is moving towards being a service compa company via iCloud and Apple Music, he said said, but it is not the high growth stock it once was.
“Apple is be becoming a much cheaper stock in valua valuation terms than it used to be, so it’s possible you’re seeing th the transition to it being a more boring, cash-generating busine business,” said Mr Beauchamp. The co company has a large cash pile, w while a smartphone is now consid considered more of a staple than a luxury.
Apple would also be an obvious casualty if the trade war between America and China worsened. It has Chinese suppliers and its own factories in China, and sells millions of products there annually.
Neil Goddin, manager of the Kames Global Equity fund, said: “If the Chinese government tells people not to buy American goods, they will listen. Apple also faces many of the same risks it always has: competition is high, the smartphone takeover may be nearing the end, and it has struggled to find growth in China and India.”
Streaming service Netflix, which has a market value of $150bn, has been investing huge amounts in creating original programming – spending in 2018 is expected to be $13bn. But it has significant competition in Amazon’s Prime Video service and could face rivalry from Google and Apple too.
Mr Goddin said: “The fact customers pay $10 a month makes the product brilliant, but I struggle to believe it will ever be able to charge $20 or $30, as that enters the realm of traditional content providers.” He added that, at a price-to-earnings ratio of 153, the valuation of the company was “crazy”.
There is also a question over how effective its spending on content is. “It can outspend anybody, and is happy to, but producing so much leads to duffs and dilutes quality,” Mr Goddin said.
Like Amazon, Google relies on the money generated by one portion of its business – advertising – to invest in all of its other ventures.
The main risk, again, is that governments become unhappy with Google’s global advertising dominance. “The obvious negative ploy is regulation. American officials going after it would be bad for the stock – it’s not likely but is a concern,” said Mr Goddin.
Increased regulation could lead to higher costs and affect Google’s ability to make money from internet traffic to sustain its growth rates.
Ms Menard said: “The latest example of regulation risk is Google’s recordbreaking €4.3bn (£3.8bn) fine from the EU for breaching antitrust rules.”
Stocks that mimic the behaviour of bonds thanks to their ability to offer safe returns – often known as “bond proxies” and typically including consumer goods, utilities and telecoms firms – have thrived in the low interest rate environment. But now that Bank Rate has risen to 0.75pc, its highest since 2009, should investors be concerned?
A higher Bank Rate pushes up bond yields, as new bond issuers are forced to offer more interest to compete with cash. Bond prices fall when yields rise and bond proxies may follow suit. By contrast, other types of stock benefit from rising rates.
Banks, for example, can widen the margins between the rates they lend at and those they offer savers. That can make what bond proxies offer less attractive, especially given that many trade on pricey valuations.
Sam Ford, manager of M&G’s UK Select fund, said: “There’s a concept that there is a reliance on low rates for [bond proxies’] success. It’s easy to tar a collection of companies with the same brush, but scratch the surface and there are differences.” Firms with higher earnings growth, for example, are less of a concern.
Ben Gutteridge, of wealth manager Brewin Dolphin, cited Unilever. “It is growing earnings at 10pc a year and is still investing lots,” he said. By contrast, Nestlé “has much lower earnings growth and is more susceptible to interest rate rises”.
How quickly interest rates will rise is also significant. Stephen Bailey, a fund manager at Liontrust, said: “America, where rates have gone higher, has shown how bond proxies fall. Commodities and financials are areas we want exposure to instead.”
Switching to stocks that should benefit directly from higher rates may represent taking advantage of an opportunity rather than avoiding any potential calamity from sticking with bond proxies.
Mr Gutteridge said he would be reluctant to make a big shift into financial stocks, which are the “standard interest rate trade”.
Fund investors should watch out, too. Some funds have enjoyed huge returns from bond proxies, but be wary of managers who suddenly divert from their stated strategy.
The ‘Faang’ stocks may well have further to run, but investors should be aware of the risks, reports James Connington