Just how pricey are Aussie tech stocks?
The short answer to the above question, if you’re the type of investor who looks at PE multiples as a guide, is “very”.
Lining up some of our local names — like Wisetech (ASX: WTC), Appen (ASX: APX), Altium (ASX: ALU), Afterpay (ASX: APT) and Xero (ASX: XRO) — against the big US tech stocks — Facebook, Amazon, Apple, Netflix and Google (FAANG) — is a common comparison.
“In the US, you have very high-quality, semi-monopolistic companies with phenomenal cash flows and phenomenal earnings," Hofflin says. "In Australia, we have a lot of hopefuls on high multiples.”
The FAANGs have lifted their earnings 70% since the first COVID cases appeared outside China. Hofflin says they’ve displayed “astonishing profitability”, with profits up around 180% over the last four years.
By comparison, the earnings of the Information Technology GICS sector on the ASX have fallen 30% since last March. And over four years, the sector’s earnings expectations are down 43%.
“The FAANG stocks are the inspiration for the boom, but they are in a very different position to many other stocks,” Hofflin says. “I don't think you want to price every tech stock as if it's going to be the next global monopoly.”
In the following interview, Hofflin points to the tech wreck to demonstrate why a substantial pullback in Aussie tech stocks isn’t as “fanciful” as many people think, and reveals what it would take for him to buy some of Australia’s highest-growth tech names.
Was November 2020 the turning point in the same way that March 2000 was? Our fund is up 13% or 14% relatively, which is better than the first year after March 2000, but there is one part of the picture that doesn't fit.
On the speculative side of the spectrum, the boom is still running. The US is just marginally off yet another record in this long bull run. Bitcoin is at $63,000; meme stocks are flying high; Dogecoin is doing well.
Although they've had a very good year, we know this sort of late-cycle environment is not good for value investors. Who knows where it goes from here?
If you get any sort of inflation problem, that's going to accelerate the shift to value. But I'm not confident the old bull market is dead yet.
Comparing the US tech leaders, the FAAANGs, with our tech stocks is probably not the best comparison.
It’s a very different stage of development in the US, where there are very high quality, perhaps even semi-monopolistic, companies with phenomenal cash flows and earnings. In Australia, we have a lot of hopefuls on high multiples.
The FAAANG stocks, since the start of COVID, have increased earnings 70%. In the last four years it's been 180%. Astonishing profitability.
If I look at the ASX tech sector, since COVID started, their earnings have fallen 30%. Over the last four years, their earnings expectations are down 43%. Very different dynamics.
It's worth emphasising that, because the FAAANG stocks are the inspiration for the boom, but they're in a very different position to many other stocks. I don't think you want to price every tech stock as if it's going to be the next global monopoly.
The US tech stocks have to worry about Lina Khan and the Federal Trade Commission and anti-trust actions. And we've seen what China has done to its monopolies.
On the other hand, our tech stocks actually have to start making profits.
You can learn from history by going back to March 2000. The US clearly had a tech sector with some very good companies. I think it’s fair to say our crop didn't do so well.
We had all sorts of companies, like Sausage Software, Solution 6 and One.Tel and Davnet and so forth, all trading on 60 times. Sixty times sounds really tame compared to where they are now — our infotech sector is on 90 times.
They had phenomenal runways, but they never took off — they stayed on those runways. Our tech sector post-March 2000 fell 92%. In the US, it only fell 80% because they generally had better companies.
As we sit here today, perhaps there are better companies in Australia's mix this time round, but I think you can still fall 80%, just as the NASDAQ did back then. There are prices where we would own all of them, but it really a question of price.
We do look at all the large ones. We're very careful to make sure that we don't miss the fact that companies that invest early in the life cycle show very little profitability, but it's because they're building market share and so forth.
So we value these companies, let's say Xero, which is a really good business, on mature margins and on a market share basis. It's really the multiples that are very hard to get your head around.
To us, they just seem incredibly demanding, and when multiples are very demanding, disappointment tends to follow.
An 80% decline in prices is quite dramatic. And you might say that that's fairly fanciful, but cast your mind back to the second half of 2017.
The iPhone X came out and we found out a lot of our politicians were New Zealand citizens, but it wasn't that long ago. We were already eight or nine years into the bull market and interest rates were zero.
If the ASX GICS infotech sector today traded on the same multiple as it did in the second half of 2017, it would have to fall 79% because more than 100% of the gain in prices in that period has been multiples. They're up 400% in that time. But to go back to 2015 multiples, the sector would have to fall 83%.
When you're on very high multiples, you're expecting the market to be very patient. It's very hard to deal with shocks, particularly if there is any sort of tightening in the enormous liquidity conditions that we have at the moment, because interest rates do need to go up a little bit to stop the enormous inflation momentum.
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