Technology is by far the best performing stock market sector so far this year – something that many observers have attributed to a handful of megastars, namely Facebook, Apple, Amazon, Netflix and Google (FAANGs). Think the tech sector's fate is in the hands of a few big name stars? Think again, asks Supriya Menon, Senior Multi Asset Strategist at Pictet Asset Management.
HAND IN HAND
Share price performance, % change 2018 to date
Source: Thomson Reuters Datasteam. Data covering period 12.07.2017-01.08.2018
The bad news is that some of the FAANGs are finding the going tougher of late for a number of reasons, including increased scrutiny from regulators, lofty investor expectations and saturated markets.
The good news is that the tech universe’s remarkable performance is more broad-based than many realise; it includes numerous companies with strong earnings and attractive growth potential.
Indeed, although the big stars have certainly contributed to overall tech gains this year, the rest of the sector has also done very well. True, the S&P 500 Information Technology index1– where Apple alone accounts for 15 per cent and the top 10 constituents make up nearly two-thirds of the market capitalisation – gained 12.8 per cent in the first eight months of 2018. But its equally weighted version – where every stock has the same degree of influence – is up 12.3 per cent. If only a few stocks were rallying, we would not see that.
Looking at earnings gives some insight as to why the tech world is now about more than just the top names. While FAANGs comfortably outperformed the rest of the sector in terms of earnings before interest and tax (EBIT) growth 2014-2015, that performance has since evened out (see chart).
EARNINGS SUCCESS NOT LIMITED TO FAANGS
EBIT, % growth year-on-year* The S&P 500 IT index does not include Amazon or Netflix.
Source: Pictet Asset Management, Thomson Reuters Datasteam, Bloomberg. Data covering period 30.06.2011-30.06.2018
This pattern isn’t just true for the latest quarterly earnings results, but also about the overall trend. Over 90 per cent of companies in the S&P 500 IT index are seeing improving earnings growth, according to our earnings breadth analysis (see chart).
WIDE-SPREAD PROFIT GROWTH
Earnings breadth for S&P 500 IT index, % of companies above 26-week moving average on 12-month trailing EPSSource: Pictet Asset Management, Thomson Reuters Datastream, Bloomberg. Data covering period 22.01.2009-02.08.2018
One reason for tech’s success, we believe, is that – unlike many other sectors – it has buyers in both the consumer and corporate markets, meaning it captures a lot of the economic dividend.
Technology companies are able to apply extensive operational leverage: they can leverage intellectual property without the need to significantly expand its fixed costs, like staff or premises. The agility of such low fixed cost business models means tech companies are able to be nimble, and pivot to the fast changing competitive environment. This is critical in the era of disruption. While the biggest companies in a sector can become more encumbered by regulatory burdens and spend much of their time addressing their relationships with society or government, the rest are left to focus on innovation.
If economic growth continues, tech should continue to benefit. And while the FAANGs are likely to remain in the news, the evidence shows that the benefits to sector extend much farther than the headlines suggest.
1) The S&P 500 IT index includes Facebook, Apple and Google’s parent Aphabet, but not Netflix or Amazon.
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