Tech Stocks

Will Technology Stocks be the Leaders of the 2020s?

by

Quiz!

8 of the 10 largest companies in the world in 1990 had something in common: what was it?

  1. They were all American.
  2. They were all technology stocks.
  3. They were all Japanese.
  4. They were all energy stocks.

Will Technology Stocks be the Leaders of the 2020s?

In 2021, the 10 largest companies in the world were technology stocks. Technology changed our lives, and the companies on the top 10 list are prominent names including Apple, Microsoft, Alphabet (Google’s parent company), Amazon, Facebook and Tesla. Investing in such a prominent sector seems like a no-brainer – they are the future, and should stay dominant. While they declined more than the general stock market in 2021, it may seem reasonable to expect them to recover fast and continue their dominance.

It turns out that every decade or so, the top 10 most valuable companies in the world were dominated by a group that people fell in love with. In 1980 it was oil stocks, 1990: Japanese stocks, 2000: tech stocks, 2010: Chinese & energy stocks, 2021: tech stocks. (See the well-written article: https://mcusercontent.com/6750faf5c6091bc898da154ff/files/8a56f057-ed95-f5a2-56e2-cc7a5b72247d/GKDailyComment221206.pdf.)

Every time, there was a rational explanation for the dominance of the companies, and the continued dominance. While the story always sounded convincing, it never worked out. The world’s production isn’t driven by one sector. By the next decade, the favorite group underperformed, sometimes with decade-long declines, and got replaced by the next favorite.

Here are several tools to identify these situations:

  1. A group of stocks dominated the largest 10 companies in the world (by market cap = investment value).
  2. The valuations of this group of stocks were extremely high (measured by Price/Book Value, or P/B).
  3. The bubble popped, and the group of stocks underperformed the rest of the market for a number of months.

Once all 3 happened, the initial declines were not followed by a return to dominance in the following decade. Can you guess how many of these 3 applied to technology stocks in 2021? All 3! Seeing the dominant groups of stocks in each of the recent decades, can you guess the dominant group in the 2020’s?

Note that this article discussed investments, not intrinsic values of companies. To understand better, Price = book x price/book. The book value (or intrinsic value) of a company can grow nicely, but if the price/book starts very high and corrects itself, the price can still decline or grow much more slowly. This is how some great dominant companies in each decade end up being poor performers as investments.

Quiz Answer:

8 of the 10 largest companies in the world in 1990 had something in common: what was it?

  1. They were all American.
  2. They were all technology stocks.
  3. They were all Japanese. [Correct Answer]
  4. They were all energy stocks.

Explanation: Read this month’s article for more.

Disclosures Including Backtested Performance Data

Should I buy or sell Apple Stock?

by

Quiz!

What is the impact of Apple’s share buybacks on its P/E, and should you adjust for it?

  1. The share buybacks lowered Apple’s P/E in the past 3 years. At this rate, Apple’s cash will be gone in less than 3 years. Since this is not sustainable, you should adjust for it.
  2. Apple is a highly profitable company with desirable products. Its profits should keep generating cash to support share buybacks for the long run. There is no need for adjustments.

Should I buy or sell Apple Stock?

Apple is a very successful company, with strong demand for their products.  As an investment, I see conflicting messages in their financials:

  1. The Price/Earnings (P/E) of 21 is not extremely high (https://www.macrotrends.net/stocks/charts/AAPL/apple/pe-ratio).
  2. The Price/Book (P/B) of 41 is stratospheric, about x20 higher than the average for the S&P 500 (https://www.macrotrends.net/stocks/charts/AAPL/apple/price-book).

The problem?  Apple did massive share buybacks, reducing its cash on hand by 55% within about 3 years (https://www.macrotrends.net/stocks/charts/AAPL/apple/cash-on-hand).  Share buybacks reduce the number of shares, increasing the earnings per share, and lowering the P/E.  At the current rate, Apple’s excess cash will go down to $0 in less than 3 years.  Assuming continued success, with no change in earnings growth, something has to give within the next 3 years: a drop in the stock price, or a big increase in the P/E, resolving some of the current anomaly.

The solution? You can estimate the annual impact of share buybacks on Apple’s P/E in the past 3 years, and adjust for it, as part of a full analysis of the stock. QAM focuses on value investing based on the more reliable, stable and thoroughly studied P/B, and diversifies stock portfolios into 1,000s of stocks.

Quiz Answer:

What is the impact of Apple’s share buybacks on its P/E, and should you adjust for it?

  1. The share buybacks lowered Apple’s P/E in the past 3 years. At this rate, Apple’s cash will be gone in less than 3 years. Since this is not sustainable, you should adjust for it. [Correct Answer]
  2. Apple is a highly profitable company with desirable products. Its profits should keep generating cash to support share buybacks for the long run. There is no need for adjustments.

Explanations:

  1. Please read this month’s article above for an explanation of this point.
  2. While Apple is profitable, a realistic valuation should reflect a sustainable future, including a stable level of cash. With cash dropping fast in recent years, an adjustment is needed.
Disclosures Including Backtested Performance Data