How to Cope When the Tech Bubble Bursts

The last thing you want to do is lose money.

So what should you buy? Something that’s bound to go up over time.

But which stocks are those?

Most will point you to the FAANGs, an acronym for Facebook, Inc. [NASDAQ:FB]Apple, Inc. [NASDAQ:APPL]Amazon.com, Inc. [NASDAQ:AMZN]Netflix, Inc. [NASDAQ:NFLX] and Alphabet, Inc. [NASDAQ:GOOG] (Google).

If you want something a bit more exotic, the next best choice is China’s BATs (Baidu, Inc. [NASDAQ:BIDU]Alibaba Group Holdings Ltd [NYSE:BABA] and Tencent Holdings Ltd [HKG:0700]).

Disruption, innovation, earnings growth. The companies above have it all. It’s why so many investors jumped into the FAANGs and BATs with full gusto.

But have we taken things a little too far?

We’re always hearing the words ‘tech bubble’. Unlike the 2000s, this one is far more concentrated. They’ve been a favourite investment for years.

But is the party now over?

 

Are we in a tech bubble?

Take a look at Facebook, The Australian Financial Review (AFR) said. A record US$119 billion of their market value was wiped off in a single day.

If that doesn’t tell you we’re heading for a tech plunge I don’t know what does.

Facebook’s misstep sent a shudder through the FAANGS (an acronym for the US tech giants Facebook, Amazon, Apple, Netflix and Google-parent Alphabet), as investors began to question whether they’d been correct to assume that their stunning growth rates could be continued indefinitely.

For a while analysts have warned about rosy outlooks. Nothing lasts forever. Not even growth from the FAANGs and BATs.

But for the longest time, these tech giants have defied the odds. They don’t behave like the large conglomerates of the past.

They’re far quicker and better at growing into new industries. All of which adds to their already huge potential earnings power. As the AFR continues:

‘…eventually, their growth rates inevitably slow once these companies become dominant players in mature sectors.

Until now, investors plugged their ears to any suggestions that the high-growth FAANGs could falter. Instead, they saw the FAANGs as on track to enjoy spectacular growth as the digital revolution continued to cut a swathe through global economy.

Particularly since, taken together, the FAANGs dominate consumers’ use the internet – Facebook (social media), Google (for search engine and maps), Amazon (for shopping), Apple (for mobile devices), and Netflix (entertainment).

Yet I wouldn’t bet on a 50% drop. [openx slug=inpost]

 

What makes a good investment?

The market is extremely unpredictable in the short run.

It’s entirely possible you’ll see huge share price declines for the high flying FAANGs and BATs. Periods of little to no price movement are just as likely, maybe more likely than a huge drop.

For the moment let’s forget about stock prices.

The FAANGs and BATs are all wonderful businesses. They take little to no capital. And they all generate massive returns on whatever they reinvest.

I’ll use Netflix as an example.

Like most subscription services, Netflix receives money upfront for future services. This cash, for a short period of time, is similar to free money.

Instead of borrowing money short-term, for which they’d have to pay interest, Netflix can use customer’s cash to grow their operations.

The amount they’ve already invested has paid off handsomely in the last two years.

From 2015-17, Netflix retained US$790 million. Over the same time, the company generated an additional US$436 million in profits.

That means Netflix generated a 55% return on each dollar reinvested.

If this sounds amazing, it’s because it is. And it’s a similar story for the other FAANG and BAT stocks.

But a wonderful business is one thing. A wonderful investment is something else.

Even though Netflix can generate massive returns, the stock is not worth an unlimited price. And you’d think a triple digit price-to-earnings (PE) ratio is a tad high.

 

Who will feel the effects of a slowing tech industry?

Whether you invest in the FAANGs or BATs is completely up to you. You’re the steward of your capital. And as steward you need to make intelligent, well thought out decisions.

But even if you weren’t comfortable buying any of the above, what happens to them is still a matter of interest. Giant tech is likely far more important than you think.

When there’s talk of government regulation, trade wars and antitrust actions, it doesn’t just impact shareholders. The economy will feel the effect of slowing FAANGs and BATs.

Big tech is now one of the biggest corporate spenders in the economy. Amazon for example spent $US25 billion last year.

They were the world’s fourth largest spender, just above Gazprom (a Russian energy monster with 172,000km of pipelines).

From The Australian:

In America, if you include all firms, public and private, tech accounts for an estimated fifth of all investment across the economy and at least half of the absolute growth in investment.

The boom has four causes. First, tech firms are undertaking activity on behalf of other companies. Instead of building data centres, non-tech companies lease capacity from cloud-based providers such as Amazon Web Services (the giant’s cloud arm) and Microsoft, and in China, from Alibaba and Tencent. AWS is investing $US9bn a year, or about the same as General Motors.

…Second, the online and physical worlds are blurring…A third trend is that tech firms are acquiring access to technology and data.

…A final probable cause of the investment boom is sheer indiscipline. One warning sign is a rash of flash property activity. Apple’s new headquarters in California reportedly cost $US5bn. Finalising the doorknob designs took a year and a half.

Of course you should always look at events from a long-term perspective. But you don’t need to be a shareholder to feel the effects of a slowing tech industry.

Your friend,

Harje Ronngard

Daily Wealth

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Harje Ronngard is one of the editors at Money Morning New Zealand. With an academic background in finance and investments, Harje knows how difficult investing is. He has worked with a range of assets classes, from futures to equities. But he’s found his niche in equity valuation. There are two questions Harje likes to ask of any investment. What is it worth? And how much does it cost? These two questions alone open up a world of investment opportunities which Harje shares with Money Morning New Zealand readers.


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