It has been a fantastic year so far to be a technology investor.
The Fang (Facebook, Amazon, Netflix, Google) stocks are leading again and are now up 33.6 per cent on average year to date.
Add Tesla and Nvidia into the mix, and we have a group of businesses that capture the imagination of both Wall Street and Main Street.
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Together, these companies represent over $1.8 trillion of market capitalisation, and they share a common characteristic: they are all disruptors. They have all managed to turn several traditional sectors upside-down.
Bricks and mortar retail is fighting to stay alive in a world with Amazon – Toys R Us recently declared bankruptcy.
Traditional media companies are struggling to cope with both the shift to digital advertising and the shift to consumption of their content “over the top” (where you don’t need a full video subscription).
The energy sector is seen by many as a victim of an imminent collapse in oil demand due to the shift to electric vehicles.
The iPhone reached its tenth birthday this year, and who would have thought it would achieve what it has.
Many companies such as Uber would not be viable without it. Many others, such as Blackberry, lie in its wake. And yet more have re-invented themselves to survive in the new mobile world (look at the recent success of video game publishers).
As investors, understanding disruption is critical, yet successfully predicting it is impossible (for us at least).
Technological steps forward come in waves, and we are riding on the top of one just now.
The waves require a confluence of external factors to build, and in this cycle, central bank zero interest rate policies have had a major effect. How else can you fund such massive expenditures without sufficient cash flow generation?
The promise of the future looks most compelling when you discount future cash flows at a near zero rate. While the potentially lucrative prospects for the disruptors mentioned above have not been lost on investors, it also pays to look at the side effects.
There will be permanent victims. Even just the thought of disruption can materially impact a share price, as investors panic that current fundamentals are about to collapse.
And even if they don’t collapse, it can take a long time for investor confidence to rebuild.
The food retail sector is right in the middle of this debate just now. We should be looking for who is next. Can Amazon be your pharmacy?
But sometimes the initial prognosis doesn’t turn out as bad as first thought. It was only five years ago that Wall St detested Microsoft because Apple was going to move into the corporate world and the lucrative Windows and Office businesses were going to get destroyed.
But look at Microsoft now. It generates over $31bn of free cash flow, the stock is up over 140 per cent in five years, and nearly three quarters of the 34 Wall St analysts who cover Microsoft are positive on the stock today. How quickly things can change.
Tesla can be a successful company, but it does not mean that we will witness the death of the internal combustion engine in our lifetimes, let alone in the next five years.
The massive challenges that electric vehicles face to become a mass market product (substantial reduction in battery costs, range improvement, infrastructure build out) may mean that these traditional businesses will fare pretty well over the next several years, allowing them time to adjust to the new world that lies ahead.
This may also apply to some other “disrupted sectors” such as energy.
These could be where the big stock market opportunities now lie.
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