TechnologyJun 1 2021

What is really going on with tech stocks?

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What is really going on with tech stocks?
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It is easy to miss things right now in the world of tech investing.

After all, it feels like we have had 10 years’ worth of excitement and upheaval in the space in one and a half.

The year to date is no exception and it can tell us a lot about the future.

By and large, tech stocks have had good earnings seasons this year; a result of our lives being increasingly led via our home wifi connections. 

However, they have also had two sharp corrections recently, one in March and one in May.

These were seemingly driven by a combination of inflationary fears, managers positioning their portfolio for the desperately awaited post-Covid recovery, and possibly also profit-taking ahead of US President Joe Biden’s proposed reforms to capital gains tax. 

We have also been hearing a lot about semiconductors – specifically that they are terrifically important and there is a shortage of them, but most of us remain unclear on what that actually means or why they are so important.

Then, to top it off, you have everyone’s favourite tech mogul flirting with abandoning fiat currency before swiftly re-embracing at least part of it; resulting in the bitcoin bubble deflating, for a short time at least.

Disrupted disrupters

So, you would be forgiven for missing a more subtle signal that provides an indication of tech investing post-Covid: the market is learning to distinguish between exciting, but profitless, ‘disrupters’ and profitable tech-based ‘enablers’.

Over the past six weeks, these ‘disrupters’ – typically fashionable, high-growth companies that have or claim to have proprietary tech – have fallen 30 per cent.

Whereas the ‘enablers’ – the companies selling the pickaxes in the gold rush – are holding steady or making modest gains over the same period.

This divergence can be seen in the chart below, comparing the performance of two investment funds focusing on very different types of company. The ARK Innovation Active ETF is focused on disruptive businesses, often small and loss-making, but growing very fast and with astronomic valuations. 

In contrast, the BlueBox Global Technology Fund largely ignores disrupters, and instead concentrates on very profitable enablers, where those profits are consistently outgrowing the market. 

Both funds had extremely good performance in 2020 (ARK’s was truly spectacular), but while BlueBox’s enablers have held their own since mid-February, ARK’s disrupters appear now to be trending back downwards fast.

This performance comparison puts the issue into sharp focus, but there were signs this was on the horizon.

Investors are, and have been, growing increasingly sceptical of companies that have changed the way we live our lives, but are yet to generate a profit.

The most pronounced recent example of this was Deliveroo and its damp squib of an IPO.

Ahead of its listing, the food delivery company and its cadre of advisers were adamant that the ‘tech company’ warranted its prestigious multiple and that it was steal at a valuation of £7.5bn.

The company even sought to lure in retail investors with an in-app prospectus so you could order a biryani, invest for a rainy day, and support the company’s aim of becoming profitable, all in one go.  

But is Deliveroo a tech company?

Deloitte thought so and, in 2018, crowned it the UK’s fastest growing technology business.

But it is not a tech company: it is a disrupter – specifically it is a food delivery business using tech to disrupt its industry.

It is not even that innovative: the tech to connect restaurants, drivers, and hungry people already existed elsewhere. Just Eat and Uber Eats each have a greater market share, with 53 per cent and 27 per cent of the UK’s food delivery transactions in 2020 respectively.

Moreover, the company’s meteoric rise has only been made possible by the thousands of gig-economy workers peddling bikes across UK cities while the rest of us sit at home, which sounds distinctly low-tech when you think about it.

As with the WeWork palaver in the US, investors on both sides of the Atlantic are growing sceptical of chasing the producer of the latest exciting gadget or the next pony-tailed entrepreneur promising disruption.

After all, these disrupters swing between success and obscurity, and their value follows accordingly.

Moreover, disrupters more often than not fail or are disrupted in turn, and investors are once again learning this the hard way – think BlackBerry, GoPro or FitBit for earlier examples.

As the world reopens and the Covid-19 boost dissipates, we anticipate that stock-pickers will increasingly favour the companies behind every disrupter’s success.

These are the businesses that disrupters depend on, whether suppliers of semiconductors, software vendors powering popular apps, or services companies integrating systems or providing infrastructure such as public cloud.

They may be boring, and they may be hard to understand, but these companies take a share of every disrupter’s success and that is, by far, the better position to be in.

Semiconductors

Manufacturers of semiconductors – computer chips – are a prime example.

Anything involving information technology relies upon at least one semiconductor, and possibly tens of thousands of them.

Currently, they are in scant supply as the production lines are very difficult and very expensive to establish. This has meant shortages in everything from Ford’s trucks to Sony’s PlayStations.

Such is the gold rush in this space that a confederation of South Korean conglomerates with government-backing announced earlier this month that they would spend a staggering $451bn (£318bn) on developing semiconductor production in the next decade.

Investors have started to grasp the importance of these tech infrastructure providers and are beginning to learn to distinguish between the enablers and disrupters, but confusion still permeates the market.

For example, weakness in technology stocks in February and in early March was, in part, down to confusion surrounding the widely reported semiconductor shortage.

This was until investors remembered that a global semiconductor shortage is an indicator of strength of demand in the tech sector, not weakness, causing the likes of Applied Materials to spike 13 per cent, NXP to rise 11 per cent, and Texas Instruments to increase in value by 10 per cent.

The pandemic has accelerated demand for a wide range of tech-enabled services in almost every industry vertical and the resulting shortage of semiconductors will take the remainder of the year to work through.

Discerning the enablers

The challenge for tech investors post-Covid will be maintaining the deep knowledge required to understand and identify the companies that are powering the disruption: the enablers.

These are the cloud software services as opposed to the fintechs, the chip manufacturers as opposed to the electric car companies, and the online payment platform as opposed to the restaurant delivery business.

The disrupters may be more exciting as stories, but again and again the enablers have turned out to be far better long-term investments.

William de Gale is lead portfolio manager at BlueBox Global Technology Fund