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QD view – Are you still watching?

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It is no secret that the US is the biggest player in the technology space, with a market value of about $1.5trn compared to a global market value of around $5.2trn.

The country is home to some of the biggest tech firms in the world and probably the next generation of them with almost 500,000 private tech companies, many of which are start-ups.

So, what does it mean when a tech giant like Netflix sees its shares plummet by more than 35% in one day, erasing more than $50bn in market capitalisation from a company whose stock was already down more than 40% on the year? That’s what happened on Tuesday (19 April) when the online streaming service announced it had lost subscribers for the first time in more than a decade.

In response to the news, Pershing Square Holdings (PSH) told its investors it had sold its stake in Netflix, saying it had ‘lost confidence in [its] ability to predict the company’s future prospects with a sufficient degree of certainty’.

Manager, William Ackman, said: ‘Based on management’s track record, we would not be surprised to see Netflix continue to be a highly successful company and an excellent investment from its current market value. That said, we believe the dispersion of outcomes has widened to a sufficiently large extent that it is challenging for the company to meet our requirements for a core holding.’

Asset Value Investors, which holds PSH as its largest position in its £1.2bn AVI Global trust (AGT) at 9% applauded the decision, telling Investment Week that ‘selling out was brave […] it appears Pershing have learnt from past mistakes and have demonstrated commendable discipline’.

Of course, Netflix blamed an array of factors from the war in Ukraine to people sharing passwords. However, subscribers might argue that the streamer just isn’t what it was anymore, with many TV favourites now removed from the service while rival media companies have developed their own streaming apps, many of them at debatably better value.

This is a story unique to Netflix but the fundamentals may not be so unique to the trajectory of US big tech.

Christopher Berrier, portfolio manager of Brown Advisory US Smaller Companies (BASC), said in a webinar which QuotedData attended this week, that large-cap companies, particularly in the tech space, tend to hit a road bump the bigger they get.

‘They tend to penetrate their end markets,’ he said. ‘They get to a point where saturation exists and then they are no longer able to grow at reasonable rates due to the revenue base being quite big compared to the end market.’

Growth versus value

Technology companies tend to fall into the growth basket and growth stocks have had a torrid time, taking a turn for the worse at the start of 2022 as the direction of inflation and interest rates caused a sharp rotation into value.

The North American Income Trust (NAIT), which benchmarks itself against the Russell 1000 Value Index, has little exposure to technology compared to other sectors, with just a 7.2% weighting as at the end of February 2022.

In its annual report released earlier this month, the manager said that it benefited from its overall positioning in the technology sector, which was one of the primary laggards during the year to 31 January 2022.

But BASC’s Berrier believes as the discount process runs its course, the backdrop for growth investing will improve compared to value.

‘Value tends to outperform following periods of economic weakness such as that brought about by the pandemic,’ he said. ‘Value came back and relative earnings have been good as the economy has recovered. Rising interest rates are worse for growth in the short term, but over the long-term, if you think about leverage in the US equity market, most of this will be on the value side.

‘As rates go up, should they stay high, the actual cost of capital on the debt side for a lot of value companies is going to go and interest costs will be higher which is bad for earnings growth on the value side as we move into 2023.’

Another bubble?

A popular line of questioning is whether we have been in the middle of a tech bubble and if so, is it popping? A tech bubble usually represents an unsustainable market rise attributed to increased speculation in technology stocks. Rapid share price growth and high valuations based on standard metrics, such as price/earnings ratio or price/sales are some of the characteristics of a bubble.

Despite the market turmoil caused by the pandemic over 2020 and 2021, tech companies soared as companies and countries alike were forced to pick up the pace on digital innovation and employers had to work out how to let their employees work from home.

The extent to which the pandemic pulled forward demand and artificially inflated sales growth is debatable, and probably company specific. Research from Forbes found chip producers NVIDIA and Advanced Micro Devices were among the biggest winners from the pandemic, as demand for computing devices surged. Combined with a shortage of chips, this pushed up chip prices. The two companies’ share prices peaked in November and have fallen back a long way since. Yet quarterly sales numbers continue to climb.

Meanwhile, the so-called metaverse is ever-expanding and definitely doesn’t think a mere bubble is going to get in its way. Polar Capital Technology’s (PCT) manager, Ben Rogoff, describes it as ‘a collective virtual shared space, created by the convergence of virtually enhanced physical reality and physically persistent virtual space, including the sum of all virtual worlds, augmented reality, and the internet’.

The metaverse is years away and therefore can easily be dismissed as little more than a buzzword. However, in time it could represent the next stage of the internet, not just in a ‘successor to the smartphone’ sense but as a logical next step for humankind and how we are connected.

Rogoff added: ‘The pandemic showed we can be apart and together at the same time which is the foundation/vision of the metaverse.’

One thing that’s for sure is that nobody is sure what’s going to happen. Growth stocks, and therefore the lion’s share of tech stocks, are struggling at the moment as inflation remains at a 40-year high and concerns of further interest rate rises are depressing the valuations of stocks whose earnings are being discounted for a number of years into the future. This doesn’t mean that the outlook is diminished over the longer term, but opinions are divided on where to next for the rest of 2022 and beyond.

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