Is technology delivering on the failed promise of the Nineties dotcom bubble?

By James Connington

The technology sector has entered a new phase and is now dominated by giant - and profitable - companies such as Google and Facebook. Photo / Getty Images
The technology sector has entered a new phase and is now dominated by giant - and profitable - companies such as Google and Facebook. Photo / Getty Images

Nearly two decades after the spectacular boom and bust of the dotcom bubble, technology stocks finally appear to be delivering on their promise.

The transformative impact of technology at the turn of the millennium has never been in dispute, but the speculative fever it inspired among investors ended in catastrophe.

Companies popped up overnight, spent fortunes to grow rapidly, then folded just as quickly after failing to deliver earnings.

Since then, the technology sector has entered a new phase and is now dominated by giant - and profitable - companies such as Google and Facebook. Share prices have been on a rising trend for many years.

What are investors, many of whom were burnt the first time round, to make of this new landscape? We put tech firms, and the funds that invest in them, under the microscope.

Valuations

Today, rapid growth in certain share prices has caused some to ask whether we are in another bubble. Amazon's share price, for example, has surged from $200 five years ago to $769 today.

But cashflows and profit margins are high, as technology businesses need to invest relatively little to generate returns.

Ben Rogoff, co-manager of the Polar Capital Technology investment trust, said:

"What we're seeing today is what the sector promised in the late Nineties, but this time it's doing it with earnings. Google has revenues of more than $45billion (NZ$62billion); in the Nineties nobody did anything with revenues."

Rogoff said questions about valuations were fair in early 2014 when Twitter went public and there were a swathe of acquisitions, but now "the market has become more discerning".

For the first time in history US technology companies now account for the five largest companies in the world, according to Bloomberg. When it comes to these dominant giants, value can often be obscured.

Emergent technology companies perform very well as businesses and share prices until they cease to. I don't know how as an investor you deal with that, except that you cannot ignore it.

Nick Train, manager of the Finsbury Growth & Income investment trust, said:

"People have been disturbed and concerned about the valuations of Amazon and Facebook for a very long time, but so far it hasn't seemed to matter.

"Emergent technology companies perform very well as businesses and share prices until they cease to. I don't know how as an investor you deal with that, except that you cannot ignore it."

Rogoff added: "The valuation question is one you should always ask, but I do think you have to be careful about what metric you apply. If you look at Amazon's price to earnings ratio, the stock has looked expensive during its last 1,000pc of growth or so."

'Invest in picks and shovels'

One approach that professional investors enthuse about is to look at businesses that supply components that will be in high demand as a new innovation progresses - the so called "picks and shovels" argument.

Jake Robbins, lead manager of the Premier Global Alpha Growth fund, flagged hardware manufacturers involved in "the internet of things" and firms that produce equipment used in the manufacturing of semiconductors in particular.

"Anyone who makes components that go into making devices wireless is seeing the next five or 10 years as a very strong growth period for their products. We own things in America called Broadcom and Skyworks; as the technology gets more complicated more of their kit is needed," he said.

He highlighted that the amount of trading based on short-term news meant companies such as these, which supply Apple, trade up and down in response to iPhone sales reports.

"What investors are missing is that the main growth area for these companies is not Apple. It's other phone manufacturers and wireless devices. This provides opportunities to buy at cheap valuations."

Cloud computing

Some of the most compelling investment cases come from technologies that attack existing sources of profit and transform current business practices.

Benefiting from these themes is arguably much easier than attempting to pick a winner from the periphery of the tech world, where there are countless companies vying for attention.

"Cloud computing", where computing power is hosted by a service provider online rather than on a company's own equipment, is one example.

Rogoff said: "You used to have to spend capital on equipment and people, put that against a problem and see whether it stuck. Now you can put a business together quickly, break even more quickly and see whether the concept works."

He said cloud computing is now at the point where it is starting to profit at the expense of existing technologies, challenging established giants of the old order.

Scale

One element that has changed significantly since the tech bubble is the scale of user bases and how quickly they can grow.

The growth of Pokemon Go, the smartphone game, to tens of millions of daily users almost instantaneously is testament to that.

But there remains the challenge of turning user numbers into money. Twitter is still struggling to convert its 300 million users into revenues, and media businesses face similar problems in making money from their online readership.

Train said: "From our perspective, the most interesting thing in technology is what attracts millions or billions of eyeballs to a given place. There is clearly extraordinary value in places that can aggregate so much attention.

"The asset that we own that begs the biggest number of questions is Mail Online, the Daily Mail's website.

Photo / Getty Images
Photo / Getty Images

"Theoretically, being the world's most visited English language website ought to be of extraordinary value. But the newspaper industry is still trying to work out how to generate cash flows from all that attention."

Tom Slater, co-manager of the Scottish Mortgage investment trust, highlighted "machine learning" as one factor that offers an advantage when it comes to scale.

He said: "Taking huge amounts of data and processing it into some sort of sensible conclusion can't be done by humans because the scale is so large and human intuition is fallible.

"Google has demonstrated over the past 10 years the ability to execute at massive scale, whether that's home-grown businesses or things it has acquired."

How to get exposure to tech

The number of dedicated technology funds and investment trusts is relatively limited, partly as a hangover from the tech bubble itself, when many folded.

But there are a number to choose from, although the five-year return figures need to be taken with a pinch of salt because of the recent weakness of the pound, which has boosted the value of US assets for British investors.

Another option is well-regarded funds that have a large weighting in technology.

Scottish Mortgage is one example, although the managers say transformational businesses such as Google and Facebook are far more wide-ranging in their influence than the "tech" label suggests.

Passive" options are harder to come by, as most of the technology indices are US based.

There are a few technology exchange-traded funds (ETFs) priced in sterling, although most use "synthetic" replication of the index they track, according to A J Bell, the fund shop, so investors should be wary.

One option that physically replicates its index is the iShares S&P 500 Information Technology Sector, available for an ongoing charge of 0.15pc.

Another option is the Close FTSE techMARK tracker fund, which follows the FTSE techMARK Focus Index. However, it does not provide global exposure.

- Daily Telegraph UK

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