If you had to act like a genuine long-term investor — to buy into one sector and hold it for ten years — which would you choose? The answer you would get from most investors would be to look for the industry where there is guaranteed growth.
That would take you straight to the huge technology companies listed in the US. They have been fabulous stockmarket performers: shares in Amazon have risen 30% this year alone and one share will now set you back nearly $1,000. They have fast-growing free cash flows and earnings-per-share growth estimated by MSCI at 18% this year (see this week’s MoneyWeek cover story by Rupert Foster). They dominate their markets. Amazon manages over 40% of book sales in the US and has a 74% share of the US ebook market. It’s getting more: overall sales were up 23% in the first quarter of the year.
Facebook has 1.5 billion users who spend an average of 50 minutes a day on the site. With its subsidiaries, it takes 70% of US social media traffic. Google is your default browser and controls 88% of search advertising. Finally, they are impressively innovative: name a technology trend that will define the future (cloud computing, home digitalisation or artificial intelligence, perhaps) and you know who is on it. It will be one of the five largest companies in the US by market cap: Apple, Alphabet (Google’s parent), Microsoft, Amazon or Facebook. Given that, who wouldn’t want to buy and hold this lot for a decade?
Me. I wouldn’t. They are too expensive for me — and getting more expensive too fast. A report just out from Bank of America Merrill Lynch notes that US growth stocks have just passed their 2000 “tech bubble” highs against global value stocks. Google, it says, is worth more than the gross domestic product of Chicago; the combined market cap of Google and Amazon comes to more than that of all financials listed in Europe and Japan.
You should enjoy that kind of statistic for its general ridiculousness. But it’s also worth noting that analysts always come out with this kind of stuff just as booms turn into bubbles. Remember how we used to laugh about the land around the Imperial Palace in Tokyo being worth more than all of California in the late 1980s? Quite. And the Nasdaq Internet index is now on an average price/earnings ratio of 61 times. That’s nothing on the dotcom bubble (the Nasdaq 100 average was 205 times) but it isn’t far off the levels of the Nikkei in the California vs Imperial Palace era (67 times).
This would be just about OK if there were no inherent risk in the business models of the big tech companies. But there is, and most of it is regulatory. Governments like to control things but right now they have very little control over Google, Facebook, Amazon or Twitter. These are all effectively monopolies (there are huge barriers to entry — owning the network is all — and there are very low marginal costs once you are in). They have long been able to pay the tax they want, treat content providers as they want and take little responsibility for content uploaded on to their sites. That doesn’t work for the state.
Consider Theresa May’s manifesto. She would like to “ensure there is a sustainable business model for high-quality media online to create a level playing field for our media and creative industries”. She intends to “work with industry to introduce new protections for minors, from images of pornography, violence and other age-inappropriate content”. And she wants the UK to be “the global leader in the regulation of the use of personal data and the internet”.
The first bit hints at protection for traditional media and regulation for new media. The second shifts the responsibility for policing content from the police and the public directly to the social media firms. If May were alone in this it would be of little interest. She isn’t.
There is a cross-party consensus in the UK that social media is not doing enough to root out fake news and terror content — and a consensus that, for those who don’t get a grip on it, very high financial penalties are the answer.
This is a trend that has added momentum behind it after the terrorism attacks of the last few weeks. May’s speech yesterday was about as clear as it could be. “We cannot allow this ideology the safe space it needs to breed,” she said, “yet that is precisely what the internet and the big companies that provide internet based services provide. We need to work with allied democratic governments to reach international agreements that regulate cyberspace to prevent the spread of extremism and terrorism planning.” I think she means it.
There is also a consensus that corporate tax rules need tweaking such that fines aren’t the only thing paid by companies operating in the UK. The rest of the world is with the programme: last week the G7 issued a statement calling on social media companies to do more to combat online extremism; Germany has legislation on the go that will fine firms up to €50m for not policing themselves.
There is also much talk in the US and in Europe about the reform of what is known as “safe harbour” for internet companies. Effectively part of legislation in both regions, this limits the liability of operators for anything nasty on their sites. Removing it, as Mrs May would like, would shift policing responsibility to the middleman. That could be expensive.
However, there is even worse than this on the way. It has been a few years since we started hearing claims that several of the big tech firms are monopolies and should be regulated or split up under competition law. Now the idea of Roosevelt-style trustbusting of tech in the US is gaining traction (Donald Trump sometimes seems all for it).
Maybe Amazon should be split by product line or Facebook forced to sell off Instagram. The tech firms will put up a huge fight against all this. But they are unlikely to get much sympathy from the general public or the politicians that represent them. After all, given the way all the money in the world seems to be heading towards the owners of tech firms, there is every chance that the next round of populism will be against the “concentrated wealth of Silicon Valley”, as Michael Hartnett of BoAML says. Invest in big tech now and you are, I think, taking something of a bet on the nasty political battle to come rather than on the current state of the sector. That’s not something I want to do.
So the question remains: what you would buy if you had to hold it for a decade? This is an almost impossible question at the moment but let’s make an attempt to answer it next week. I’d like your thoughts too — add them in the comments below.
PS Note that not all our writers agree with me. Rupert Foster’s cover story on the matter is a must read of anyone who wants to hear the other side of the story!
• A version of this article was first published in the Financial Times