Google has announced that it is to buy 300 “modular apartment units” as a way to help employees facing high housing costs in Silicon Valley. You might think that sounds generous of the firm.
Perhaps you aren’t on Twitter: the best response there to the news that Google employees could soon be living in the climate-controlled factory-produced equivalent of a tied cottage was “Google beta tests feudalism”. The tweet came from a man with only 312 followers. In 19 hours it was retweeted 18,000 times and liked 37,000 times.
What next, everyone wondered? Being paid in virtual vouchers you can only use in the on-site company store? Being paid in company scrip into a company bank? By the end of the Twitter thread, hundreds of people were probably humming along to the lyrics of the country classic Sixteen Tons (“You load sixteen tons, what do you get? Another day older and deeper in debt, St Peter don’t you call me ’cause I can’t go, I owe my soul to the company store”).
So why should this concern investors? A few years ago, an announcement that Google was good enough to house its own staff would have drawn praise. Now everyone sneers a bit and mutters that a “modular apartment unit” is just a fancy term for a static caravan.
The big technology companies are on the edge of a whole new world – one in which they are on the run from public opinion and from politics. That doesn’t mean that the things they do aren’t wonderful, thrilling, innovative and life changing for all of us. It does mean there is a pile of unpriced-in headwinds about to hit this very expensive sector, in terms of tax and regulation.
With that in mind, I have been re-reading a section from the 2015 Credit Suisse Investment Returns Yearbook. In it, Elroy Dimson, Paul Marsh and Mike Staunton of London Business School look at how investors should think about the long-term industry weightings in their portfolios.
The first thing to note is obvious (but also often forgotten). The period in which we live is not as special as we like to think it is. Periods of extreme technological advance are perfectly normal. In 1900, “virtually no one had driven a car, made a phone call, used electric lighting, seen a movie or heard recorded music; no one had flown in an aircraft, listened to the radio, watched TV, used a computer, sent an email or used a smartphone. There were no X-rays, body scans, DNA tests or transplants, and no one had ever taken an antibiotic.”
So we have seen the rise and fall of exciting new industries over and over again. It is worth remembering that canals were once a stunningly disruptive technology (if you were a horse and wagon or turnpike operator, at least). Between the late 18th century and 1824, more than 60 canal companies debuted on the London Stock Exchange, “raising the equivalent of $32bn in today’s money”.
By 1792, float turned to frenzy. But then the rise of the railways (60 times more efficient than canals) caused an almighty crash. Canal shares, say Messrs Dimson, Marsh and Staunton, had fallen 75% by the mid-1800s.
There is plenty of data to play with here if you want a hint of what your returns will be like if you stay in a new and overpriced growth sector for too long. And the answer is not great.
Most analysis into initial public offerings shows that new businesses underperform: the average underperformance for 2,499 new listings from 1975 to 2004 in the UK was about 30% in the five years after listing. Stockmarket investors aren’t often the big beneficiaries of new technology; in the past (as now) the gains have gone to the innovators, to the providers of venture funding and, of course, to consumers (the really big winners from both railway networks and search engines).
It also shows that the longer a firm has been listed (the more “seasoned” it is) the better its stockmarket performance: investors tend to overvalue the new and undervalue the old. The problem today – one that lots of you have pointed out in your emails to me on the matter of portfolios you could “lock and leave” for ten years – is that we aren’t really undervaluing either the old or the new at the moment.
Everything is expensive. The managers of the CFIC CRUX UK Fund (who are finding equity valuations “very challenging”) look, for example, at the very seasoned Unilever. An old valuation rule of thumb, they say, is that you should pay 0.1x revenue for each 1% of operating margin — so a 15% operating margin should command a multiple of 1.5 times enterprise value to revenue (known as EV/R).
Analysts’ forecasts for Unilever operating margins over the next three years come in at 16.1%,% 16.9% and 17.8% — but the current EV/R stands at 2.9 times. In other words, nearly twice what you would expect.
If nothing goes wrong — if labour costs don’t increase and product prices keep rising, for example — that could be fine. But there isn’t much margin for error in there — just as you’ll find in the tech sector and most others too.
So with prices high and with uncertainty all around us, is there any one sector we can look at as likely to be a top performer over the next ten years? CRUX suggests banks — which have been the big losers from very low interest rates and so seen “a material valuation compression”. They therefore act as a sort of insurance against rising interest rates — something that Thursday’s minutes from the Bank of England’s Monetary Policy Committee suggest could be closer than many think.
But whichever way you look at it, ten years is too long to take sector-only views. Banks could suffer from digital disruption and another wave of regulation. Rates might never rise. Fund managers will surely suffer from the rise of the cost-conscious retail investor. Oil companies could be hit by a sudden sharp rise in energy efficiency.
If the past few years have taught us anything, it is that forecasting really is a fool’s game. The upshot of all this is very boring. I’d love to pick out 20 of the best single stock suggestions from your emails on lock and leave portfolios (these range from Domino’s Pizza Poland to ITM Power and Greggs).
But the safe thing to do in times of fast change and overvaluation remains the really boring thing to do. Buy a low-cost fund that is well-diversified across industries and countries and run by a manager biased to value. You need to preserve what you already have more than risk much to grow it.
If you want something active with a few interesting investments one answer is Caledonia Investments (LSE: CLDN). Otherwise (and this really is dull, sorry) the Vanguard FTSE Global All Cap Index fund. Yours for a mere 0.24% a year.