By Bob Huxford, Partner
The Nasdaq, the US tech-led exchange that often serves as a proxy for the technology sector, hit an all-time high in Feb 2020 with a valuation over seven times that of its 2009 low point in the last recession. Compare this to the FTSE 100, where the recent high point was only double that of its 2009 nadir.
Tech giants such as Alphabet, Microsoft, Apple, Amazon etc. led the charge, all hitting new all-time highs in February even as Covid-19 was devastating parts of China. Naturally, there were plenty of voices in the market saying the tech sector was overvalued with a much-needed correction on the horizon. This was duly delivered when Covid-19 hit the Western World hardest of all and the dizzying share prices enjoyed by the US tech mega-caps were brought rudely back to Earth.
These stocks each lost roughly 25% between late February and mid-March but this seemingly overdue correction was short-lived. At the time of writing, Amazon and Netflix are trading at new all-time highs and Microsoft is within a whisker of hitting that mark. It’s as if Covid-19 never happened. But is there any justification for these valuations?
The digital revolution that was already underway is only being accelerated by Covid-19. Online retailers such as Amazon are obvious winners here. My technophobe parents, who previously wouldn’t have dreamt of buying goods or groceries online for fear their bank details would be stolen, have had no choice but to join the digital matrix and are bowled over by the convenience the online world provides. Being confined to the home has also led them to sign up to Netflix and Amazon Prime and its unlikely they’ll limit themselves to terrestrial TV again once the crisis passes.
Beyond consumer services, most all businesses are having to adapt to remote working and cloud services, so Amazon again benefits through Amazon Web Services and Microsoft through 365 and Azure. Microsoft’s Q3 results to 31 March, released Wednesday, showed revenue up 15% to $35bn and net income up 22% to $10.8bn, chiefly driven by cloud sales. CEO Satya Nadella duly pronounced: “we have seen two years’ worth of digital transformation in two months.”
Amazon’s Q1 results released yesterday showed revenue growth ahead of expectations but a miss at the earnings line owing to increased spending on staff safety and maintaining timely shipping. CEO and Founder Jeff Bezos told investors to take a seat as the $4bn they’d normally make in operating profit in Q2, and possibly more, would also be spent on meeting these costs. The share price still went up over 4%.
What we don’t yet know is the full effect Covid-19 will have on the economy but businesses and consumers alike will suffer and will be tightening belts. As the core infrastructure on which modern businesses are now built, cloud services may well be the last thing to go when cutting costs. But when things get really bad businesses will struggle to pay for even these essential services. Suppliers may have to provide grace periods or price cuts and some clients will go bust.
In addition, these mega stocks are acting as defensive plays at the moment. As they’re so well capitalised, money that might have been invested in smaller, riskier companies has found its way to these comparatively safe havens. Valuation multiples for the larger players have diverged somewhat but as we emerge from the crisis we’re likely to see a convergence back to historical levels.
Whether valuations of the giants fall closer in line with the rest of the sector or the smaller cap stocks catch up to some extent remains to be seen. Either way, despite all the economic disruption and uncertainty, there’s a lot positive expectation built into the mega caps current share prices. Let’s hope it’s not entirely unfounded.
For full disclosure the author does hold positions in some of the stocks mentioned above