My step-by-step investment process for the large tech companies
What to look at and why…
At the time of writing the stock markets are in general expensive while the uncertainty about the future, given the impact of Covid-19, are particularly uncertain. Some stocks are seemingly being driven by investors with no concern for valuations. It may not be good timing to buy any stock and one should always consult a qualified financial planner who will consider your specific circumstances before making any investment.
As such the following should not be construed as advice but rather a description of my own process. I’ve been watching the market, and have asked myself the following question:
If given a choice between Alphabet (Google), Amazon, Microsoft, Facebook, Apple and Tesla, which one would I invest my hard-earned after-tax savings into?
They are the tech goliaths of today, having (other than perhaps Tesla) become indispensable to our everyday lives and have earned tremendous income over many years. They have catapulted their founders into the global spotlight and created wealth for the founders and early investors like nothing else on earth.
When considering an investment as a lay person with limited resources and possibly a lack of knowledge of the financial markets, several approaches are worth applying. I highlight a few of these approaches which have helped me a great deal in the past.
Common sense and your own experience of a product or service.
For example, if your own experience of a certain product or service offered by one of these tech companies is wonderful, you’re extracting value from it in one way or another, and overall, it has a positive impact on your daily life, it is very likely that others will share your sentiments. Applying a little common sense and your own “take” on the product are often very useful when considering a stock and more importantly its future prospects. I am a frequent user of Alphabet (Google), Microsoft and to a lesser extent Amazon. I almost never use Facebook, Apple and Tesla products. As such, for me, I would favour the former three businesses. I like their products, they are useful, I use them every day and others must feel the same. I keep a lookout for new products they offer and I can definitely see myself using more of them in the future. Importantly as I use their products almost every day, I am close to these businesses, thus I will be in a better position to spot problems early on.
How does the company make their money? Profits, not just revenue.
For example: realize that Amazon actually makes most of its profits from its cloud services, Amazon Web Services (AWS) and not its online retail arm. In fact, Amazon dominates the cloud service market place worldwide. The information on where a company makes its money is readily available on the internet or the company’s website. I have taken the liberty of summarizing a few facts and figures further on in this article.
The share of the company’s income stream you get for your investment.
The actual quoted price of an individual stock tells you nothing about the underlying business itself and should not be used in isolation to compare stock. Largely ignore the individual stock price when comparing stocks and rather understand the earnings associated with each stock. To compare apples with apples you want to look at certain financial ratios when comparing the value of each stock in a sector. One of the most widely used ratios is the price / earnings or the P/E ratio or P/E multiple for short.
The P/E multiple is: the ratio of the share price divided by the current earnings per share, it gives one a quick overview as to the value of a company. More importantly, I use the P/E multiple to establish what a company’s value is compared to its peers in a sector.
Example: A company with the 35 P/E multiple, investors have paid $35 for current earnings and, if the subsequent earnings of the company remain unchanged, it would take 35 years for the company to earn what investors paid for it.
The higher the P/E the more earnings growth one would expect or need in the future for the investment to make sense. It could be regarded as overvalued if you don’t perceive significant earnings growth.
A low P/E is an indication that the current stock price is low relative to earnings and could be regarded as undervalued.
A low or high P/E ratio is not necessarily good or bad and I certainly don’t hang my hat on a P/E multiples alone when making an investment. However, I find the P/E multiple very useful when comparing company valuations and, if a particular company has a significantly different P/E than its peers within a sector, I want to try and understand why that is.
For example, if you look at the table below, Tesla has a P/E ratio around 1,300 whereas the rest of the tech companies are in the high 20’s to mid-30’s (except for Amazon which has a P/E multiple of around 80). The above tells us, comparing Tesla to the rest of these tech stocks, the market is pricing for significant growth from Tesla in the future. This is by far the most expensive stock in terms of how much earnings your investment buys you. Even if I doubled Tesla’s earnings for the next 3 years (i.e. 1,300÷2 ÷2 ÷2) the P/E would still be 162.5 which is more than double that of Amazon. Amazon has the second highest P/E but is significantly lower than Tesla. However, Amazon is still 2 or 3 times multiple the other names mentioned here. Facebook has the lowest P/E at around 26 indicating that investors are pricing in less growth for Facebook or a higher risk for growth in the future.
Do muted profits mean the company is struggling financially?
Not necessarily. And here you will have to do some reading up as to why. For example, Amazon has deployed what I consider a smart strategy over many years by re-investing very heavily back into its own business in a tax efficient manner. It has also used its expensive stock to buy other cheaper companies which will help it speed up delivery in its strategy. This has meant earnings have remained deliberately muted due to heavy investment cementing their position in the market, but at some point, they could really deliver strong performance. And hence the lower net operating income margin and the higher P/E multiple — investors are pricing for higher growth.
Read up on current news surrounding these tech companies
For example, an important feature of these large technology companies is the increasing scrutiny being faced with respect to anti-trust behavior. Is their size becoming an issue to the extent that consumers are being harmed or even perceived to be harmed? Increasingly this question is being asked and given their success, will this at some point become an issue. For instance, competitors using a tech company’s infrastructure have no control over what the tech company is doing with their data, and lawmakers are concerned that the tech company may use this data to the detriment of its competitor.
Another issue arising is to what extent these tech companies are manipulating the way users think. In general, a significant amount of our personal data is on the internet (which us as users put there voluntarily I might add) and with users continuously “clicking”, these tech companies get to know us more than we think. They can easily control what users see and read influencing their thinking on important matters.
I have ranked from most likely to least likely to attract this attention simply using my own experience: Alphabet (Google), Amazon, Microsoft, Apple, Facebook and Tesla.
As Alphabet (Google) in my opinion is the highest risk candidate, there is a chance that Alphabet (Google) pre-empts what would be an unpleasant experience and unbundles some of its business’ units into separate companies. The sum of the parts is usually greater than the original as the smaller units are more focused, nimbler and incur less head office costs. Hence value is usually extracted through an unbundling.
The following table very roughly breaks down the size of these companies, their revenue, net profits et cetera for 2020.
This graph shows the companies net profit margins over the last 5 years. It gives you a good a quick overview of how the companies’ profit margins have grown year-on-year as well as whether they have managed to sustain their profit growth.
And finally, the last table below gives a breakdown as where these tech giants are making their main profits. Based on my own personal research, it is clear to me that Microsoft, Alphabet (Google) and Apple have the most diversified income streams and thus most able to withstand an unforeseen shock or take advantage of new developments. However, I cannot ignore the substantial world-wide market share that Amazon controls in the cloud computing space. I do believe there is massive growth in this area in the future.
Looking at the tech giants below — where do you think their growth is going to come from? How well is company positioned to expand on new (or current) growth paths given their current infrastructure (their market reach across their various platforms, the technology at their disposal, Windows Android and iOS etc.)
So, to answer the question I posed at the start of this document:
If given a choice between Alphabet (Google), Amazon, Microsoft, Facebook, Apple and Tesla, which one would I invest my hard-earned after-tax savings into?
If I had $100 to allocate to these 6 stocks, I would invest as follows:
• $50 goes to Alphabet (Google)
• $30 goes to Amazon
• $20 goes to Microsoft
Why wouldn’t I invest in Facebook, Apple and Tesla right now?
I wouldn’t touch Tesla, it might be a great company and have an engineering genius as a leader but the price is simply too high and the competition, many large established players, is racing to catch them.
Although Apple produces high end devices, it is extremely expensive and I think there are equally good, if not better products elsewhere at more reasonable prices. And although Apple has a great online product offering within its tech eco-system, they are very reliant on that eco-system to grow. They are also very reliant on selling more iPhones to grow their services. And given the competition in the smartphone space, I think they face an uphill battle and thus are fully priced.
I used Facebook for a period, but not anymore. Just my opinion, but I don’t see how Facebook adds any real value to one’s daily life. Honestly, I just grew tired of it. Yes, it’s useful when one wants to catch up with family and friends and view their pics ever so often, but that’s just it, ever so often. I also think Facebook faces massive competition going forward as I view the barriers to entry to compete with them to be low. It would be easy to replicate, and others already have or are busy with it (WeChat, Snap, Google, Twitter, Amazon to name a few).
There you have it folks, thanks for taking the time to read this article. I have thoroughly enjoyed looking at these tech companies, I wish you the best of luck in your tech search for 2021!
