Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 209

Tech stocks: balancing realism and evangelism

Just as it is dangerous for anyone to argue “It’s different this time”, it is similarly risky for technology sceptics to doubt what may seem like absurd ideas. For example, should anyone laugh at Elon Musk’s latest claim that Teslas get better with age as software upgrades improve the car’s functionality?

This battle between reality and hope, with the realists often looking as silly as the evangelists, is a constant in technology and technology investing. Technology has changed the world and created substantial value. Yet, tech history remains littered with the likes of Blackberry, Nokia and Geocities. The latest (modest) sell-off in technology is a good time to reflect on the value created by technology and where we currently stand.

Technology has supported much of the improvement in equities from 2009. The S&P 500 Information Technology index has risen 301% since March 2009, compared to 202% for the broad S&P500 index. In the last 12 months, returns in technology of 30% were double those in the index to the end of May.

Performance of US tech stocks vs. the US market

Source: Bloomberg, weekly data, index = 100 @ 31 Mar 1997 to 19 Jun 2017

The evangelist and the realist

The balance between realism and evangelism is the combination of valuation and earnings. Fortunately, we have a benchmark for extreme evangelisation, the dot-com boom of the late nineties. From a valuation perspective, today in no way matches the experience of 1999. Yes, valuations have risen recently, but for both Price to Earnings and Price to Sales, the increase is barely noticeable by comparison. The Price to Earnings for the S&P500 Information Technology peaked at 80x and the Price to Sales peaked at a little over 7x around the year 2000. By contrast, today, the index is at 24x earnings and 4x sales.

Valuations of Tech stocks now (green line) vs. pre-2000 (blue line)

Source: Bloomberg, CFSGAM, valuations to Mar 2000 peak vs. valuations to 31 May 2017

So it is not a bubble. Indeed, it is possible, depending on your earnings view, to say that valuations in the expansion from 2005-2007 were slightly higher (with earnings higher than in 2000) than they are today.

But not being a bubble does not mean valuations are cheap. Much more important are earnings and their trajectory, and it’s useful to look at four leaders from 2000 against two from today’s FANG (Facebook, Amazon, Netflix and Google).

It is not clear from this analysis that the big constituents of 2000 were not as profitable as Facebook and Google are today. Gross margins were a little volatile around 2000 but future margins, which matter to long-term investors, have maintained high levels and greater stability. The ongoing profitability of Microsoft, Cisco, Oracle, and Intel (MCOI) is remarkable.

The evangelism of 2000 was misplaced yet the scepticism of 2010 and 2011 when valuations were at their lowest, was similarly misplaced. Oh, to have bought Facebook in September 2012!

Gross margins of the major tech companies from the year 2000 to now

Source: Bloomberg, MCOI vs. Facebook & Google, quarterly data (%), Mar 1997 - Present

The fundamental evangelist: Facebook, Adobe and Nvidia/Micron

The profitability of the industry as a whole reflects two consistent themes across a variety of sub-sectors: strong demand for products and services with increasing utility and high margin business models. For example, four companies across three sectors include Facebook on the Internet, Adobe for enterprise software and Nvidia/Micron in semiconductors.

Facebook

Facebook is a dominant player in contributing to substantial productivity improvements generated from the sharing of information and commerce.

“But the kids don’t like Facebook anymore”. This standard view misses the essential value of Facebook to its users, shareholders and the broader economy. To go all evangelist, Facebook is the social network or, alternatively, social infrastructure, creating value as users’ bulletin board. These interactions provide Facebook with the ability to offer advertising that is extremely well targeted, with businesses receiving high, measurable Returns on Investment. Many of these advertisers are new advertisers looking to advertise to a customer base that is geographically close. Facebook is changing the world, but more importantly, it is changing your neighbourhood.

The resulting profitability, particularly in the US, is astounding. Each user in the US attracted $67 in advertising in the 12 months to March 2017.

Facebook’s profitability growth depends on finding new use cases and building a sales infrastructure. The monetisation of Facebook Messenger is a good example of new use cases. The forced adoption of Facebook Messenger has been the fastest adoption cycle in internet history. It allows Facebook to drive transactions in ways similar to WeChat in China. For instance, the e-gaming company Activision used a chat bot to engage with users via Facebook Messenger. In the first 24 hours, the chat bot had six million interactions. Similarly, tools that improve the quality of advertising enable smaller and smaller businesses to have a professional online presence.

Adobe

Enterprise software is a key productivity theme in the technology sector. Firms are continually looking for ways to improve their business processes to focus on and invest in the things that matter: product development, product marketing and customer service. Adobe not only improves efficiency in many marketing functions, it also adds value to the process.

Demand for Adobe’s product comes from increasing online content, especially as the demand for professional content rises similarly. Adobe delivers that content. It uses a Software as a Service (SaaS) business model where it charges users an annual subscription for access to its Creative Cloud. Since 2014, revenue from the Creative Cloud has risen 75% on a gross margin of greater than 65%.

The use of the Cloud to drive growth for Adobe highlights two key points: new use cases and the explosion in data creation. Adobe now uses Machine Learning to help improve searches of its stock photo gallery, which in turn requires greater data storage and computing power.

Adobe Digital Creative revenues

Source: Adobe, Bloomberg, rolling four quarters (USD million), Nov 2014 - Jun 2017

Semiconductors: Nvidia and Micron

Semiconductors are the ‘picks and shovels’ of information technology. As the uses of the internet, software and computing power expand, they drive an increasing requirement for data. At the heart of data processing is the chip.

In early 2016, the market expected stable to lower demand for semiconductors over the next two years. The price of DRAM and 3D Nand had collapsed, and smartphone demand seemed to be tailing. Instead, growth has improved as new use cases for semiconductors have emerged. It started with Nvidia’s new chips for gaming but has morphed into cars, data centres, machine learning, a doubling in the memory on a standard smartphone, increasing use of sensors in industrial processes and payments. It has also emerged in demand for crypto-currency mining.

Importantly, it has also occurred at a time when the industry is as under-invested as it has been in some time. Semi-conductor companies have entered a period of demand with limited plans for capacity growth. For once, the industry seems capable of benefiting from a demand upswing.

Conclusion

Technology evangelism has been a formidable strategy over time. Amazon was $107 at the peak of the dot-com boom in March 2000, and it hit $1,000 in June 2017. That is a 13% CAGR for 17 years. And, if you bought at the bottom, the CAGR is 39%. But there have been other disasters, and every so often, a little realism does not hurt.

 

James White is a Portfolio Manager with Colonial First State Global Asset Management.

 


 

Leave a Comment:

RELATED ARTICLES

Are expectations for the Magnificent Seven too high?

banner

Most viewed in recent weeks

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

The 2025 Australian Federal election – implications for investors

With an election due by 17 May, we are effectively in campaign mode with the Government announcing numerous spending promises since January and the Coalition often matching them. Here's what the election means for investors.

Finding the best income-yielding assets

With fixed term deposit rates declining and bank hybrids being phased out, what are the best options for investors seeking income? This goes through the choices, and the opportunities and risks involved.

What history reveals about market corrections and crashes

The S&P 500's recent correction raises concerns about a bear market. History shows corrections are driven by high rates, unemployment, or global shocks, and that there's reason for optimism for nervous investors today. 

Howard Marks: the investing game has changed

The famed investor says the rapid switch from globalisation to trade wars is the biggest upheaval in the investing environment since World War Two. And a new world requires a different investment approach.

Welcome to Firstlinks Edition 605 with weekend update

Trump's tariffs and China's retaliatory strike have sent the Nasdaq into a bear market with the S&P 500 not far behind. What are the implications for the economy and markets, and what should investors do now? 

  • 3 April 2025

Latest Updates

Investment strategies

4 ways to take advantage of the market turmoil

Every crisis throws up opportunities. Here are ideas to capitalise on this one, including ‘overbalancing’ your portfolio in stocks, buying heavily discounted LICs, and cherry picking bombed out sectors like oil and gas.

Shares

Why the ASX needs dual-class shares

The ASX is exploring the introduction of dual class share structures for listed companies. Opposition is building to the plan but the ASX should ignore the naysayers and bring Australia into line with its global peers.

The state of women's wealth in Australia

New research shows the average Australian woman has $428,000 in net wealth, 40% less than the average man. This takes a deep dive into what the gender wealth gap looks like across different life stages.

Investing

The two most dangerous words in investing

Market extremes are where the biggest investment risks and opportunities lie. While events like this are usually only obvious in hindsight, learning to watch out for these two words can alert you to them in real time.

Shares

Investing in the backbone of the digital age

Semiconductors are used to make microchips and are essential to a vast range of technology and devices. This looks at what’s driving demand for chips, how the industry is evolving, and favoured stocks to play the theme.

Gold

Why gold’s record highs in 2025 differ from prior peaks

Gold prices hit new recent highs, driven by a stronger euro, tariff concerns, and steady ETF buying – all while the precious metal’s fundamental backdrop remains solid amid a shifting global economic landscape.

Now might be the best time to switch out of bank hybrids

In this interview, Schroders' Helen Mason discusses investing in corporate and financial credit securities, market impacts of tariffs, opportunities for cash investments, and views on tier two and hybrid bonds.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.