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The fastest growing of these mega caps were Amazon and Facebook

Technology stocks have continued to outpace broader equity markets in 2018. Together Apple, Amazon, Google, Facebook and Microsoft have a market cap value of $3.6 trillion and a net cash balance of just over $365bn. These quarterly earnings reports epitomise a virtuous circle of cash generation, investment and share gains - part of the technology sector fly wheel.

“Technology stocks have continued to outpace broader equity markets in 2018. Together Apple, Amazon, Google, Facebook and Microsoft have a market cap value of $3.6 trillion and a net cash balance of just over $365bn. These quarterly earnings reports epitomise a virtuous circle of cash generation, investment and share gains - part of the technology sector fly wheel.

“Technology has accounted for the vast majority of earnings growth of the S&P 500 in the last 10 years. Of the top 20 global spenders on R&D in 2017, nine of those companies were technology companies. The cash that these companies are generating is being heavily reinvested in new technologies, propelling new products and future growth. These new product developments have pushed the sector towards the fourth wave of computing - artificial intelligence. New user interfaces such as 3D sensing, augmented reality and voice have become more evident through 2017, with the iPhone X, Amazon’s Alexa devices and Google assistants featuring heavily on Christmas lists. Apple revealed last night that it sold a record 77.3m iPhone’s in Q4, while Google and Amazon sold “tens of millions” of their virtual assistant devices. To support these devices and services these companies are also reinvesting heavily in next generation infrastructure - cloud infrastructure and access to machine learning.

“Apple and Microsoft were the most pedestrian growers of these titans while still growing sales faster than the broader market or economy at 13 and 12% respectively. For Apple, the company and investors are increasingly focused on the 1.3bn active installed base (+30% in the last 2 years the company revealed) and Apple’s ability to monetise those accounts (services grew over 17%). The announcement that the company would be comfortable with a close to zero net cash balance (vs current $163bn) opens the door to significant shareholder returns in the form of increased dividends and share buybacks, which will buoy both earnings power and stock price, even with slower than historic growth of iPhone unit sales.

“Alphabet saw sales up 24%. The Google core search platform was the main driver of Alphabet’s earnings and search volume on Google, with the volume of clicks rising 43% on the quarter (offset slightly by fall in cost per click of 14%). Alphabet faces increasing traffic acquisition costs (in part due to payments to partner Apple for operating Safari search) which has inhibited operating leverage. The Google search engine is a sophisticated AI tool and Alphabet has been finding new areas to leverage this expertise into applications, driving growth with value in its other platforms such as its cloud platform, YouTube, and in its “Other Bets” division such as healthcare venture Verily and Way Mo (one of the leaders in autonomous driving).

“The fastest growing of these mega caps were Amazon and Facebook. Despite concerns over user engagement and changes to the core newsfeed, Facebook reported revenue up 47% year on year. The company is focusing more on community and interactions - which lends itself well to taking share in the over $50bn local advertising market. Facebook has significant opportunity to grow advertising dollars away from core US Newsfeed, with opportunity at its Instagram and WhatsApp platforms and well in emerging markets such as India which is now its largest user market. The key challenge for Facebook will however be to show that user engagement and user growth has not peaked and that its platforms remain relevant enough to provide sustainable long term growth..

“Amazon best exemplifies the technology fly wheel in action, leading in R&D spend and in terms of growth of dollars added. The company added $41bn in sales in 2017 alone - an impressive acceleration at scale with the quarterly sales in Q4 rising 38.5%. Whole Foods saw significant acceleration in sales under Amazon’s ownership and overall North America e-commerce growth continues to outpace international growth despite being more mature – likely reflecting the flywheel of high levels of Prime membership in the US. Amazon is increasingly viewed as a brand, a portfolio of companies and services in e-commerce, advertising, media, logistics, IT infrastructure and more recently healthcare. Amazon reinvests it’s cash quickly and investors get rare glimpses of its potential long term profitability. Investors in the company appreciate that traditional short-term earnings metrics do not capture the value of the future growth potential at the company.

“Within the results, the global tech titans were all keen to stress the investments their companies were making in the US, including job creation and training plans. Apple recently announced a $350bn contribution to the US economy over the next 5 years ($5bn in advanced manufacturing fund and 20k jobs), Amazon are hiring more than 100k people, Alphabet plan to open 5 new data centres in the US and Facebook plans to double its capex to over $14 billion . All of which is in keeping with the idea behind US corporate tax reform and will likely appeal to the current administration. However, it is more than just political appeasement - tax reform is facilitating easier use of cash from overseas and higher levels of capex and R&D, as well as likely increases in returns to shareholders. This is the flywheel pushing technology share gains in full motion.”

Alison Porter 5 February
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