SMSFs have been increasing their holdings in technology stocks. Should they continue to add to, or reduce, those holdings?
One in 10 (11 per cent) SMSFs that own international shares has a holding in Apple. A similar percentage hold Alphabet (Google), with Microsoft and Amazon also among the top SMSF holdings, according to data from software group Class. ATO data shows SMSFs collectively held more than $4.3 billion in overseas shares at 30 June 2017, with the United States market the favoured destination.
Investors in Apple have seen their shares jump by more than 58 per cent since the election of Donald Trump as US president.
Apple has come to dominate the global handset market (by profit). While it has built an extremely attractive model, we note the ongoing degradation in its smartphone gross margins in recent years, falling from over 50 per cent in 2011 to less than 40 per cent in the year ended September 2017. The size of Apple’s handset profit pool and need for growth mean it must walk a tightrope of innovation-based pricing to sustain both margins and growth.
To this end, the technology giant’s most recent pivot, with the launch of the 10-year anniversary iPhone X, has been to significantly raise prices compared to prior generations. While investors have celebrated the introduction of new features, we have been concerned Apple’s pricing strategy will test even its most loyal customers, ultimately limiting the appeal of the new devices. Add to this the revelation it has been secretly manipulating the performance of older generation handsets – deliberately slowing the processor – and iPhone owners may feel rightly aggrieved that they are being groomed for future upgrades.
Consumer loyalty is hard won, but can be easily lost. Expectations of an iPhone ‘super cycle’ in our view look overblown. Apple may well find the market clearing price for recent innovations is much lower if it is to sustain and indeed grow its valuable installed base.
Add to this an increasingly saturated smartphone market with lengthening replacement cycles and our enthusiasm for the world’s most popular technology name is tempered.
Three reasons to avoid crowded technology favourites
Risks of investing in the major US technology stocks include:
1. Regulation: Big technology companies are coming under increased scrutiny by governments around the world because of their size, influence and role in society, particularly around managing sensitive information. This may eventually attract tighter regulation, limiting companies’ ability to monetise their users.
2. Fierce competition: Another risk among technology mega-caps is that their sheer size means they are increasingly bumping into one another’s domains. Whether it’s Amazon, Netflix and now Apple competing on content streaming or Amazon’s Alexa threatening Google with its voice search capabilities and challenging its core product search ads business, technology titans are butting heads. Likewise, Google is attacking Apple by launching its own smartphones and Microsoft is attacking Amazon’s AWS cloud business with its successful Azure platform. Expect more of this.
3. Market positioning: These high-growth stocks have become excessively crowded trades as investors have paid for growth in a low interest rate environment. If interest rates normalise, they’re vulnerable, and improved global growth could not only brighten the prospects of out-of-favour cyclical stocks, but force long-term global interest rates higher. That sounds like a contradiction – because growth itself has been scarce, attracting premium valuations in securities that have exhibited this characteristic.
Other tech opportunities
On the other hand, changes to the US tax structure could also enliven corporate activity as capital is repatriated back to the US and in so doing unleash a wave of acquisitions that could put unloved value technology stocks in play.
Value technology companies include:
• NetApp, a multinational storage and data management company that is traded at 11 times cash flow, cheap for a business that isn’t heading for extinction. NetApp has an extremely viable stand-alone future, but equally could sit inside a Cisco and would represent a modest acquisition for them.
• Twitter, the unloved yet influential media platform that changed the way celebrities and politicians exert power. Twitter ultimately belongs inside a Google or even traditional media company that perhaps failed to anticipate the rise of social media.
Twitter trades at five times revenue compared to Facebook’s multiple of 14 times. Twitter is unique as a modern broadcast platform, but has until recently been shunned by the market and potential suitors, with its shares having collapsed from near $70 in 2014 to lows last year of close to $14 a share.
You have to look at each opportunity individually. We look for companies affected by short-term uncertainty where the market has lost sight of longer-term business prospects – typically expressed through depressed valuations. Investing with a margin of safety, and multiple ways of winning, we believe yields a sustainable performance with fewer negative surprises over the cycle. Antipodes is also majority owned by its investment staff, creating an aligned performance culture.
