Are tech shares like Afterpay and Facebook are a good long-term investment option?

Welcome to Finance and Fury, the Say What Wednesday edition. 

Today's question comes from Mike -

"Hey Louis, Wondering if you think buying Tech shares are worthwhile" 

We have the FANG and the WAAAX – US – FANG - Facebook, Amazon, Netflix and Google Aus – WAAAX - Wisetech, Afterpay, Altium, Appen, and Xero (known collectively as the WAAAX stocks)  Intro Find that the nature of investments is very binary – some are very for it, some against it – like BTC True with tech companies - some with no earnings profile - so polarised the local investment community Those buying into the company brand, then those buying based around values and trends

 

Factors –

Valuations and Fundamentals – Are they a bubble or good long term holds?

forward price-to-earnings ratios – Growth shares normally about 25 to 30 in AUS, USA lower at about 15-25 – for tech different FANG share - average is a 50 PE WAAAX - over 100 times forecast earnings to almost 170 times earnings for the 2019 FY The valuation premium for growth is elevated today relative to history; software in particular now carries the highest multiples since the Tech Bubble – Back 2000 just before the bubble burst When valuations are this stretched it doesn't take much for the bubble to burst – shock to confidence investors are still licking their wounds after a Yuan-induced rout that dragged their financial universe from record highs – By product of trade war and currency war – had to devalue Yuan

Interest rates - ultra-low interest rate environment.

Investors are still coming to grips with a world where - more than a decade after the financial crisis - there is around $US12.5 trillion of global debt with negative yields. lenders are paying borrowers for the privilege of handing over their money - It has driven money out of the banks and into anything with a decent yield – shares are the dumping ground It has also had a major impact on the technical valuations of stocks in a world where interest rates are not going up for a long time to come. Appen, Afterpay and Altium which have been bid up significantly year to date as bond yields have collapsed. lower discount rate increases the PV of future cash flows, justifying higher valuations as interest rates fall, and fuelling multiple expansion driving gains to date = reason why the Pes on shares look sky high Example - rates drop from 10% to 5% = a 40% increase in the dollar value of earnings in five years’ time, but a 420 per cent increase in the value of a dollar earned in 20 years’ time. Leading to very high prices for profitless companies, because there is almost a religious belief that all of these companies will make lots of money in the future and therein lies the error

Hype and market concentrations – comparisons to other companies and markets

profitless companies are back in vogue and sometimes valued in the tens of billions of dollars 80 per cent of US initial public offerings in the first three quarters of last year had negative earnings. Wisetech, a logistics software company - worth as much as Qantas with a $8.5 billion market cap. Qantas reported revenue totalling $16.6 billion in 2018 and a net profit of $1.14 billion. Wisetech recorded revenue of $221 million and a net profit of $40.8 million. Altium is worth a billion dollars more than JB Hi-FI - a profit roughly one-seventh that of JB Hi-Fi's $234 million. Atlassian - revenue had finally exceeded $US1 billion for the financial year just ended at $US33 billion The major reason for the jump in value has been the astounding re-rating of the earnings which has meant the market is ascribing a much higher value to each dollar of earnings for this group than traditional stocks. He prefers Google and Facebook which, as the Australian consumer watchdog reported last month, have unprecedented market dominance when it comes to their monopoly on the personal data of billions of people. The two companies are also unrivalled exponents of the network effect: Where the value of a service increases with every additional user. Thematic and risks to these companies When you compare prices to values, they are so divorced from each other at the end stages where dumb money is willing to pay anything for a piece of this growth. WAAAX companies – have something over local companies – world wide consumer bases – reach huge potential for Afterpay, or the ability of these companies to scale so quickly. You need to make sure that the adoption curve is playing out, because if the acceleration slows then that’s a real risk given a discounted cash flow valuation is based on a multi-year time period Who are the consumers of these companies – some of world's most valuable consumers - the Millennial and Gen-Z generations – spend a lot and don’t have the money, but are aware of Credit cards This is a signal to me – growing spending, not saving, historically = occurs before the burst Competition - The news comes just days after the Commonwealth Bank announced it had invested $US100 million in Afterpay's US rival Klarna, and unveiled plans to bring its service to Australia and New Zealand. Afterpay risks – Needs to find finance for every new customer – needs to access capital to grow

 

 

Thanks for the question – may do a deeper dive into each of the shares in the future -

 

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