By Adam Lloyd
The spectacular rise of FAAMG (Facebook, Apple, Amazon, Microsoft and Google) along with mega bulls like Tesla continues to force stock market professionals to re-assess the way they value certain companies and tech stocks in particular.
In a recent blog by my colleague, Bob Huxford – How might technology stocks perform in 2021 – looked at the case for further outperformance of shares that have already delivered amazing returns. The fundamentals underpinning the FAAMGs are undeniably strong. They are in the most part extremely well managed, with big revenue streams and hugely cash rich balance sheets. Most importantly, they are forecast to keep growing in 2021 and it’s the growth that investors are banking on to keep the shares prices heading upwards.
The bulls will tell you that these companies are redefining the world and the way we live, work and communicate and that the old ways of valuing businesses are just as obsolete as the old ways of doing business. In some respects they are right, we are living in times of great change as we wrestle with existential issues like global warming and the threat of pandemic disease. Bricks and mortar retailing is in steady decline across much of the world as more and more of us do our shopping online and the pandemic has pushed even the luddites amongst us manage our lives through smart phones. Zero emission vehicles are not just the future they are here now and electric vehicle sales in Europe have already eclipsed those of diesel.
Microsoft is now over 40 years old and a proven global leviathan. its shares have had their ups and downs over the years but 2020 saw revenues jump by a third and the shares price responded accordingly, capitalising the business today at over US$1.5 trillion. That’s more than 40 times annual sales and a very big vote of confidence in the next 40 years of the company’s existence. Microsoft is a great business with a proven track record but can it really keep growing at 30% a year and how much bigger can it possibly be than it is already?
When compared to Tesla the Microsoft share price performance and valuation looks pedestrian. Elon Musk’s business is valued at a more modest US$750 billion but with just about 500,000 cars sold in 2020 that comes in at US$1.4 million per car! The world’s biggest producer, Toyota, is valued at roughly US$20k per vehicle sold and Europe’s biggest car maker, VW, is valued at just US$9k per vehicle sold.
So what if the most innovative and exciting electric vehicle company is worth more than all the other car companies combined. Who cares that the biggest selling electric vehicle in Europe in 2020 was actually a VW and that Tesla lost market share? For many, Tesla is the next big thing and until proven otherwise the only way to play the electric vehicle revolution.
The issue for the Tesla acolytes should not be whether we will eventually do away with the internal combustion engine because we all know that day is coming. The question to be answered is who will make the next generation of zero emission vehicles? For Tesla to justify its current valuation it will need to be the global market leader. Last year, during a global pandemic, total car sales topped 64 million, so even if that already depressed figure drops further Tesla will have to increase production by as much as 50 fold. It’s possible but in all likelihood the world’s biggest producer of electric vehicles is more likely to come not from the US, Europe or Japan but from China or even India. What value Tesla’s shares then?
Back 1997 when Amazon came to the market we marvelled at the vision of its founder Jeff Bezos who convinced investors to back his bold dream to change the world of book selling. Now the business is almost a verb like Hoover or Google and last year generated revenues of US$370 billion with estimates for 2021 approaching US$440 billion. That gives us a much more down to earth valuation of about 4-5 times sales and also perhaps a better idea of what value to put on a global success story.
As with Microsoft and any other established global player the issue has to be how much bigger can they get? As US businesses the increasing risk associated with scale has to be anti-trust lawsuits. The US has a long track record of breaking up monopolies and now we see both Google and Facebook facing multiple lawsuits brought by a range of the US judicial bodies, from more than 30 individual states all the way to the federal level with the Justice Department and Federal Trade Commission.
Tech stock valuations will always remain high because that’s where the best growth and opportunities are to be found but that does not mean it will always be the same names grabbing the headlines.