For more than 2,500 years, the Chinese game of Go has continued to attract new players, making it perhaps the oldest board game in the world with an unbroken history – it is also probably the most complex. Its longevity makes last month’s watershed all the more striking: in a game held in May in the city of Wuzhen, near Shanghai, the current world number one lost to a computer programme called AlphaGo.
Meanwhile, half the world away in Detroit, the chief executive of Ford was losing his job after less than three years in the post, to be replaced by the head of the company’s driverless cars division. The carmaker’s chairman said that the new chief executive would modernise the business by focusing on artificial intelligence, robotics and 3D printing.
It is all too easy for investors to get carried away by such developments, as many found to their cost when the dotcom bubble burst in 2000 – and tech stocks have certainly been rising at a dizzying pace in 2017. The Nasdaq Composite Index, which is dominated by tech companies, has gained more than 14 per cent so far this year. As for the broader S&P 500, the top 10 stocks account for almost half the index’s 7.7 per cent gain this year, and much of that has come from the FAANGs (Facebook, Apple, Amazon, Netflix, Google).
Stocks, of course, do not move in perfect lockstep with underlying realities – or even with changing prospects. Yet the rate at which the profitability of technology companies has increased in recent years has been phenomenal. In its early days, many investors wondered how Facebook would ever turn a profit, yet it took the company just five years – and it has never looked back. Facebook made more than $1bn (£784m) in net income in the final quarter of 2016 alone.
Quarterly profits will of course buck and rear, but there are strong reasons to believe that technology’s recent rise is merely the thin end of the wedge – and that better is yet to come.
One investor who shares this conviction is Hamish Douglass, chief executive of Magellan Asset Management in Australia. He points to Moore’s Law, which was coined in 1965. George Moore, co-founder of Intel, had observed a trend: that the capacity of a microchip doubles roughly every couple of years.
This observation is often applied to technological development more broadly. Take, for example, the fact that today’s standard issue iPhone is more powerful than Cray-2, which in the 1980s was the world’s most powerful supercomputer – and you have a sense of the pace of development. Yet Mr Douglass believes that we are just at the beginning of a wholesale shift.
One example he cites is driverless cars. Douglass forecasts that driverless car sharing will be introduced within the next 15 years. Given that the typical vehicle remains stationary for 23 hours a day, the potential for productivity improvements is enormous – not to mention the potential for drivers to save money on purchasing, insuring, maintaining and parking.
As ever, one of the best places to address your doubts about such claims is the insurance industry. Yet recently Amanda Blanc, the UK chief executive of Axa, said that a baby born in 2017 may never need to take a driving lesson – and that self-driving cars are set to cause fundamental disruptions to the business of insurance.
Moreover, the opportunities for investors to tap into technology’s rapid pace of growth are increasingly global. Beyond Silicon Valley, other technology centres are emerging. The UK has developed a number of significant technology clusters – London, Bristol, Cambridge and Manchester all come to mind – and received twice as much technology investment in 2016 as any other European country. Aside of new technology stock listings in London, there are plenty of tangible signs too. In May this year, Google submitted architects’ plans for a new European headquarters in King’s Cross – it will house more than 4,000 staff and will be as long as The Shard is high.
Yet the fact remains that recent share price rises have been dramatic. The five largest companies worldwide by market capitalisation are all technology companies (even if Amazon.com technically sits in the consumer goods bucket). Facebook, Apple, Amazon and Netflix are all up more than 30 per cent this year, and Google is up by 25 per cent. Their combined market capitalisation is now over $2.4 trillion (£1.8 trillion), nearly as big as the whole of the FTSE 100. Little wonder that some value investors feel nervous, despite the sector’s buoyant earnings growth.
However, just as it is easy to lose your head when stocks are rising, so it would be myopic to view the sector through the lens of the tech bubble of the late 1990s. The reality is that the technology sector offers exceptional opportunities, and can deliver exceptional levels of growth. Moreover, these gains can sometimes be delayed, meaning investors need to be patient.
Google’s business model relies on providing ‘free’ information in exchange for personal data – and then harnessing that data to new services. Amazon.com was often willing to miss out on turning a profit in order to increase market share, leading many investors to question the business model. Yet the company has posted a profit for the last eight quarters – revenue was $36 billion (£28.2bn) in the first three months of this year.
All of which suggests that, while these companies are disrupting dozens of industries and transforming how we exchange information and do business, they are not in fact upending the best principles of investment.
Investors can draw two lessons. Firstly, an investor’s attitude to a sector should rarely be binary – avoiding a sector entirely means that you miss out on tapping into its growth potential, while limiting yourself to a single sector makes your portfolio vulnerable to sudden sectoral swings. Ideally, technology stocks should form part of a broader portfolio.
Secondly, investors need to avoid trying to ride short-term waves of market enthusiasm, and focus instead on the company’s balance sheet, its business plan, its long-term outlook and, of course, its price. For all its latent power, technology cannot upend financial gravity.
Chris Ralph is chief investment officer at St. James’s Place
Key points
Tech stocks have been rising at a dizzying pace in 2017.
Some forecast that driverless car sharing will be introduced within the next 15 years.
Technology stocks should form part of a broader portfolio.
