MARKET COMMENTARY

Information Technology Stocks: What’s Next?

Jonathan Curtis in San Mateo delves into familiar mega stocks, emerging opportunities and how the pandemic is accelerating digital change on multiple fronts.

08.03.2020 - Fiduciary Trust Canada

Jonathan Curtis in San Mateo delves into familiar mega stocks, emerging opportunities and how the pandemic is accelerating digital change on multiple fronts.

“The pandemic is accelerating the pace of digital change on multiple fronts.” - Jonathan Curtis

Q: What’s your sense of the investment climate for information technology stocks?

Jonathan Curtis: Heading into the COVID-19 crisis, the tech sector was leading, driven by the digital transformation that’s underway. We’re in the early stages of every company in every sector integrating technology much deeper into their operations to better understand and serve their customers and to improve their business processes with technology. It’s akin to rewiring your home, except here we’re talking about rewiring the global economy. We’ve been working with this major theme of digital transformation for a few years.

The pandemic is accelerating the pace of digital change on multiple fronts. Everyone, from consumers to patients to entrepreneurs, employees and c-suite executives, has recently experienced a great deal of retraining. Digital technologies have never played a more integral role in our lives. Likewise, given COVID-19 realities, we think firms that have been lagging in their technology investment will increase their commitment to digital transformation coming out of the crisis in order to remain competitive and grow. Given the magnitude of digital disruption that’s happening, we believe it’s important for local grocery stores, medical offices, schools, financial services firms, etc., to make such changes.

Looking across the 11 S&P 500 sectors, we believe information technology stocks remain a pretty good place to put an incremental investment dollar. We expect to see sustained outperformance from some smaller names as well as big platforms such as Apple, Google (Alphabet) and Amazon.

Q: Is it fair to say that some of the very large tech firms are like utility companies in today’s world?

Jonathan Curtis: Absolutely. The likes of Amazon or Google or, to a lesser extent, Facebook, or even some smaller names like Twilio or ServiceNow are behaving like utilities. The depth of data and insights they have on their clients makes them very difficult to disrupt. In that regard, these are very good businesses, which contributes to their investment appeal.

Q: Investors sometimes wonder at the pace of growth for the big five: Facebook, Amazon, Apple, Google (Alphabet) and Microsoft. In your view, what’s going to drive their sustained growth?

Jonathan Curtis: Let’s look at a few examples, noting the digital transformation that’s unfolding. From a shopping perspective, Amazon is clearly a utility and their shopping service will be an area of ongoing growth as e-commerce still represents less than 20% of US retail sales.[1] The other part of Amazon’s story lies in cloud computing. That’s an approximate $40-billion-a-year, mostly recurring revenue business, with good margins in a total addressable market we believe could eventually reach $3 trillion in size.[2] Their subsidiary, AWS (Amazon Web Services), is the market leader and is well positioned to grow for many years to come.

Google—the leader in search—is also an efficient advertising platform, reaping more than 20% of its revenue from ads.[3] We see additional growth in the big opportunities that exist with Google Cloud, Google’s video and entertainment offerings, and G-Suite, their expanding productivity business.

Then there’s Apple, where hardware— from the storied Mac to its most recent wearables—has played a major role. However, Apple’s future growth opportunities are in the services (i.e., music, television and storage), which they’re layering on top of their hardware. We believe there’s a long runway for growth here as the company assumes the role of digital organizer for consumers. Apple is also investing heavily in adjacent categories like health care and electric vehicles, which could be significant opportunities for this firm.

Q: How do you view the policy and regulatory discussions focused on companies such as Google, Facebook and Amazon?

Jonathan Curtis: It’s understandable that, from a regulatory and public policy perspective, legislators are examining the powerful hold these businesses have on various segments of the economy and our daily lives. There’s a risk new regulation could affect the growth path for these companies and we’re watching this risk closely as part of our ongoing work. We could also make the case that breaking up some of these businesses and lessening their concentration could surprisingly end up being good for their shareholders.

Q: What role do these platforms play in the portfolio?

Jonathan Curtis: We do own many of the big digital disruptors that everyone knows about. However, we also own emerging digital disruptors that investors are just coming to understand, and those vendors that are going to help the rest of the economy become much more digital.

Within that framework, the big five are core holdings in the portfolio, but we’re particularly excited about some of the less understood, smaller companies that we own. Many of these smaller companies, we believe, can be sources of significant alpha generation in the years ahead. Examples of such holdings include Salesforce, Shopify, ServiceNow, Twilio, Cloudflare, Workday and DocuSign.

Q: Looking ahead, where are you seeing the ripple effects of the pandemic already changing the landscape for individuals and tech companies alike?

Jonathan Curtis: Telemedicine or remote medicine comes immediately to mind. For years, there’s been lots of discussion about its benefits, but there’s never been a compelling reason for widespread change. Through this crisis, doctors and patients have adapted quickly, since not only were routine physical visits prohibited, people have been leery of going and sitting in medical offices. Think of all the routine engagements that happen in the health care system—cold checkups or prescription refill visits. All these engagements can be made more productive if done remotely over video. As care providers seek to better understand and serve their patients, having a doctor’s office check in, or follow up with you through digital channels can make life easier.

We’re starting to see remote medicine gain momentum. There’s a company in the portfolio called Twilio, which helps businesses engage with customers via text or video. The firm recently worked with Epic Systems, which has a quarter of a billion patients on its software platform.[4] In the space of about three weeks, they built telehealth capabilities that could meet doctor/patient remote health care needs. The result works just fine. So, that’s one area where, coming out of this crisis, we’re seeing a new market emerging.

Q: What would you ask investors to be mindful of as they look at the tech sector?

Jonathan Curtis: Information technology has traditionally been seen as a sector to visit, a sort of cyclical means of boosting performance. While we acknowledge the sector can be more volatile than others, it offers excellent structural growth, many high-quality business models and trades at an appropriate valuation relative to the broader market. Given these dynamics, we believe investors need to start thinking about the sector as a core part of their portfolio.

 

 

Footnotes:

1. Jessica Young, “US ecommerce sales grow 14.9% in 2019,” Digital Commerce 360, February 19, 2020, https://www.digitalcommerce360.com/article/us-ecommerce-sales.
2. Joseph Tsidulko, “Amazon Web Services Closes In On $40 Billion Run Rate,” CRN, January 30, 2020, The Channel Company, https://www.crn.com/news/cloud/amazon-web-services-closes-in-on-40-billion-run-rate.
3. “Company Reports,” as of June 29, 2020.
4. Nico Grant, “Epic Systems Builds New Telehealth App With Help From Twilio,” Bloomberg Technology, April 30, 2020, https://www.bloomberg.com/news/articles/2020-04-30/epic-systems-builds-new-telehealth-appwith-help-from-twilio.

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