From Musings on Markets, Feb. 26, 2015:
As the NASDAQ approaches historic highs, Apple’s market cap exceeds that
of the Bovespa (the Brazilian equity index) and young social media
companies like Snapchat have nosebleed valuations, there is talk of a
tech bubble again. It is human nature to group or classify individuals
or entities and assign common characteristics to the group and we tend
to do the same, when investing. Specifically, we categorize stocks into
sectors or groups and assume that many or most stocks in each group
share commonalities. Thus, we assume that utility stocks have little
growth and pay large dividends and commodity and cyclical stocks have
volatile earnings largely because of macroeconomic factors. With “tech”
stocks, the common characteristics that come to mind for many investors
are high growth, high risk and low cash payout. While that would have
been true for the typical tech stock in the 1980s, is it still true?
More specifically, what does the typical tech company look like, how is
it priced and is its pricing put it in a bubble? As I hope to argue in
the section below, the answers depend upon which segment of the tech
sector you look at.
A Short History of Tech Stocks
My first foray into investing was in the early 1980s, as the market
started its long bull market run that lasted for almost two decades. In
1981, the technology stocks in the market were mainframe computer
manufacturers, led by IBM and a group of smaller companies lumped
together as the seven dwarves (Burroughs, Univac, NCR, Honeywell etc.).
Not only were they collectively a small proportion of the entire market,
but of the list of top ten companies, in market capitalization terms,
in 1981, only one (IBM) could have been categorized as a technology
stock (though GE had a small stake in computer-related businesses then):
During the 1980s, the personal computer revolution created a new wave of
technology companies and while IBM fell from grace, companies catering
to the PC business such as Microsoft, Compaq and Dell rose up the market
cap ranks. By 1991, the top ten stocks still included only one
technology company, IBM, and it had slipped in the rankings. However
even in 1991, technology stocks remained a small portion of the market,
comprising less than 7% of the S&P 500. During the 1990s, the
dot-com boom created a surge in technology companies and their
valuations, and while the busting of that boom in 2000 caused a
reassessment, technology has become a larger piece of the overall
market, as evidenced by this graph that describes the breakdown, by
sector, for the S&P 500 from 1991 to 2014:
 |
| Market Capitalization at the end of each year (S&P Capital IQ) | | |
(click through to enlarge)
There are two things to note in this graph.
- The first is that technology as a percentage of the market has
remained stable since 2009, which calls into question the notion that
technology stocks have powered the bull market of the last five years.
- The second is that technology is now the largest single slice of the
equity market in the United States and close to the second largest in
the global market. So what? Just as growth becomes more difficult for a
company as it gets larger and becomes a larger part of the economy,
technology collectively is running into a scaling problem, where its
growth rate is converging on the growth rate for the economy. While this
convergence is sometimes obscured by the focus on earnings per share
growth, the growth rate in revenues at technology companies collectively
has been moving towards the growth rate of the economy.
The Diversity of Technology
As technology ages and becomes a larger part of the economy, a second
phenomenon is occurring. Companies within the sector are becoming much
more heterogeneous not only in the businesses that they operate in, but
also in their growth and operating characteristics. To see these
differences, let’s start by looking at the sector and its composition in
terms of age at the start of 2015. In February 2015, there were 2816
firms that were classified as technology companies, just in the United
States, accounting for 31.7% for all publicly traded companies in the US
market....MORE
