Global Equity Spotlight Episode 7: Part 2

Karena
Hello everyone, and welcome back to Market Insights, a series where we delve into interesting topics affecting equity markets. Today I have Cornelius and Jacques joining me. Thank you guys for being here again. So Cornelius, the last time we discussed how the US tech stocks have dominated S&P 500 returns, primarily driven by earnings growth. Could you perhaps shed some colour on this.

Cornelius
Yes. So these are amazing companies which are really aggressively reinvesting into their businesses. So if you look at the amount of capital expenditures, percentage of revenues that has doubled since 2015, it has gone from 8% to 15% of revenues while keeping the research and development intensity close to the 15% level. And if we look at the amount of CapEx and R&D in absolute terms, these US tech giants are now actually outspending other capital intensive sectors like oil with Shell and Aramco and Exxon features as well as pharmaceuticals with Merck and Roche and those type of companies are spending a lot of money as well as auto manufacturers like Volkswagen.

So these companies are really investing in their business, and we are seeing a growing contribution from the cloud businesses for companies like Amazon, Microsoft as well as alphabet, and it’s becoming a significant contributor to them because their cloud businesses have tripled over the last six years. And Nvidia is, of course, been a big beneficiary of all this CapEx spend. And if you look at the total earnings growth for these companies, it has continued to grow at a rapid pace. And we’ve recently seen alphabet outstripping Microsoft and Apple in terms of absolute profitability. So the historic growth has been very impressive.

These companies have generated a lot of cash flows and then are reinvesting it into the businesses. If you think about, what multiples you pay for, it’s interesting that the capital intensity depresses the free cash conversion. So arguably the price earnings ratios don’t tell the full story and they’re much more expensive these days on a free cash flow multiple, but on the flip side, you can argue that R&D mustn’t be experienced fully in a given year.

So if you capitalise a portion of that again your price earnings multiples probably overstated. So you have these two different factors that you need to consider. But the fact that these businesses have a lot of growth runway is sure.

Karena
That’s really interesting, thank you. So Cornelius touched on valuations, how expensive are these stocks versus history and the rest of the market?

Jacques
So looking at the valuations of these businesses specifically the price earnings ratios, I think they should be seen in the context of the superior historic earnings growth that these businesses have delivered, but also their future prospects, right. Companies like Google, for example, has derated from more than 20 at the beginning of the year to a 18 and a half forward at the moment, or Amazon wing for more than 32 or 26 forward.

We also don’t think comparisons to the dotcom bubble and the nifty 50 is justified, firstly because the business models is completely different, but also these businesses are now only trading at a 20% or premium to the market compared to the dotcom bubble, where they traded at more than 50 multiples and 100% premium to the market. So therefor think that the valuations of these businesses are reasonable, but we do remain overweight some of the names and underweight others. And we’ve used the volatility provided by Liberation Day in April with a broad selloff in the market to take our US underweight technology business from -7% to equal weight. They’ve rallied quite aggressively now and we’ve used some of this rewriting to take profits.

Karena
Amazing. Thank you so much for those insights on the current positioning in the portfolio Jacques. To the audience, thank you so much for tuning in and we look forward to seeing you next time.