A combination of scale and innovation makes technology a very attractive sector for investors, but continuous change means risks are real.
In November 2007 the front cover of Forbes, the American business magazine, carried the headline:
ONE BILLION CUSTOMERS—
CAN ANYONE CATCH THE CELL PHONE KING?
At the time, the Finnish company enjoyed 49.4% of the mobile phone market worldwide.1 Having already taken its users with it through numerous iterations of handheld phones, Nokia appeared unassailable.
In 2014, however, with its revenue at around a third of 20071 levels, the company was acquired by Microsoft. Today, the smartphone market worldwide is dominated by Apple and Google, the latter through its Android devices.
“Consumer devices is a tough market,” says Dom Giuliano, deputy chief investment officer at Magellan Asset Management. “The leading consumer device makers rarely have longevity, for example, Blackberry, Motorola and Sony.”
If technology companies can fall quickly, they are able to rise at least as fast, and to become some of the biggest revenue generators in the world. The two largest listings on the S&P 500 as of 1 April were Apple and Microsoft. Facebook (founded in 2004) and Amazon sit at seventh and twelfth, respectively, while Alphabet (Google’s parent company) has two listings at thirteenth and fifteenth.
As technology’s applications increase, tech companies make forays into ever more sectors of the economy. CEOs regularly speak of employing “disruptive technologies” to overturn large sectors of the economy, such as Amazon in the book market or Uber in the taxi sector.
“Technology is changing the world,” says Giuliano. “There is a huge and growing online audience, and companies are introducing innovations all the time, innovations that enable greater connectivity and mobility.”
These changes are affecting everything from food delivery (now a priority new business area for Amazon) to payment methods.
“People are switching from using cash and cheque to making electronic payments, but there is a long way to go: 85% of the world’s transactions are still by cash or cheque,” says Giuliano. “Even in the UK, some 50% of transactions [by number] are still conducted by cash or cheque. As an investor, it is significant that there are only a handful of companies profiting from the switch.”
Magellan has therefore invested in payment networks MasterCard and Visa. Giuliano points out that it is banks that run the payment default risk on credit card transactions, not payment networks themselves. The payment networks get paid for simply switching transaction details between a merchant’s bank and the cardholder’s bank.
But technology stocks have been overbought before; the technology bubble of 2000 was among the most egregious examples of enthusiasm trumping analysis on markets. For long-term investors, bottom-up analysis remains key to selecting the right companies, as does close familiarisation with the rapid developments underway in the technology sector more broadly.
One company that has managed to hold market share as others have fallen by the wayside is Apple. Despite increasing competition on smartphones, especially from Samsung, the company’s pricing and margins have not faced significant pressure.
“Most of Apple’s revenue and gross margin is attributable to the iPhone,” says Giuliano. “The company was even able to increase the price of the latest handset when launching the iPhone 6. You can save 40 cents a day by switching to some cheaper Android smartphones instead, but then you’d have to leave the Apple system – the Apple ecosystem.”
That ecosystem has been fundamental to the company’s success, tying you to the company’s products for music, computing, telephony and more besides. Not all Apple’s new ventures have been successes – sales figures for Apple Watches and Apple TV consoles pale beside those of the iPhone.
But Giuliano is impressed by the reliability of its growth, while the subscription payment system (a centralised billing system customers can use – and personalise – for all Apple products) appeals to many investors. Moreover, Apple still has plenty of untapped markets.
“Apple provides increasingly annuity-like revenues for investors, thanks to the recurring iPhone upgrades made by existing loyal iPhone customers,” says Giuliano. “Plus they’ve yet to really hit emerging markets.”
The opinions expressed are those of Dom Giuliano of Magellan Asset Management and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or by St. James’s Place Wealth Management.
1 Magellan, 2016