Some of the most popular tech-related stocks of the past decade have gone from making people rich to being among the weakest performing names on the market. Are the worst of the falls over for the likes of Amazon (AMZN:NASDAQ), Tesla (TSLA:NASDAQ) and other market giants of their kind? Read on to find out.
The reasons behind the sudden drop in share prices last year for this group are twofold. First, the value of their shares was negatively impacted by rising interest rates meaning investors were no longer prepared to pay a premium to own the stock. The shares fell due to a ‘derating’, namely they traded on a lower multiple of expected earnings.
Second, all the companies suffered from either strategic, operational, regulation or reputational issues. Amazon, Tesla, Meta Platforms (META:NASDAQ), Microsoft (MSFT:NASDAQ), Netflix (NFLX:NASDAQ), Alphabet (GOOG:NASDAQ) and Apple (AAPL:NASDAQ) reminded the world that even the most successful companies can suffer setbacks.
This second area is the prime focus of this article. Whereas the issues around their derating – inflation, interest rates and central bank policy – are out of the companies’ control, they can address the other factors. Hence why investors need to look closely at the problem areas when deciding if they want to keep the shares, buy more, or get out completely.
Before we start our analysis, it’s worth noting that a medium-term investor in these shares won’t have lost out completely. Yes, the average share price decline for this group from the 2021 peak to early January 2023 was 46%. While alarming, an investor who bought any one of these shares – apart from Meta Platforms – five years ago would still be sitting on a capital gain if still held today. We discuss the performance figures in each company section.
ALPHABET (GOOG:NASDAQ) $92.26
THREE AREAS TROUBLING INVESTORS
Doubts whether Google can still lead in a changing online advertising market
Need to cut costs in a tighter macroeconomic cycle
Regulatory clampdowns and stiffening competition
For years seen as one of tech’s safest bets, 2022 saw the owner of Google hit the skids and its share price slammed. Missing revenue and earnings forecasts in each of its first three quarters of the year was unprecedented as Alphabet’s core digital advertising business came under pressure as consumer spend tightened and advertisers reined in marketing budgets.
This could be merely cyclical but with digital advertising now accounting for about two-thirds of all advertising dollars, grabbing larger market share will get harder in future due to heightened competition. For example, social media platform TikTok continues to attract large amounts of traffic which means advertisers are having to think where best to spend their money – TikTok, Alphabet-owned YouTube or both.
Despite these challenges, there are reasons to be optimistic. Fundsmith Equity (B41YBW7) manager Terry Smith believes the current market pressures should lead Alphabet to have a sharper focus on its main revenue and profit engines of search and online advertising. Smith would like Alphabet to ditch much of its ‘hugely loss-making’ non-core businesses, including the Waymo self-driving technology operation.
Alphabet’s Google Cloud business grew by 38% in the third quarter of 2022 and now accounts for about 10% of the company’s overall revenue, so it’s a handy business to have in the structurally growing cloud computing space.
The pace at which Alphabet can reel in expenses to prevent significant margin erosion will be vital to keeping investors onside in what could be another volatile year for the company.
The shares are cheap for a business of its calibre, trading on 18.5 times forward earnings. Therefore, using some of its vast $100 billion-odd cash pile for further share buybacks seems sensible with the stock trading at a historically low rating.
On a 10-year view the shares have still delivered a 395% return – with the shares going up faster than the growth in earnings per share of 209%. [SF]
DISCLAIMER: Steven Frazer own shares in Fundsmith Equity.
AMAZON (AMZN:NASDAQ) $95.09
THREE AREAS TROUBLING INVESTORS
Global pressures on consumer spending
Regulatory concerns and need for cultural realignment of the business
Stiffening competition in cloud services
E-commerce giant Amazon (AMZN:NASDAQ) surprised investors after announcing (5 January) the biggest jobs cuts in its history, with 18,000 staff heading for the exit.
Although the cuts look big, they only represent 1% of Amazon’s workforce of 1.5 million. CEO Andy Jassy told employees the changes will allow the company to ‘pursue our long-term opportunities with a stronger cost structure’.
The company spent heavily on recruitment and new warehouses during the pandemic to help it cope with the surge in online business and now it needs to adapt to the new post-pandemic reality.
The challenge for the business now is to get back to what it does well and deal with a potentially cash-strapped consumer. We expect Amazon to use its unique strengths and ingenuity to do more for less and pass on cost savings to customers.
A December 2022 settlement with EU regulators on antitrust matters staved off heavy fines and gives foreign merchants increased access to sell items on the platform.
In the long run Amazon needs to be more transparent on its business model to prevent future regulatory scrutiny.
Unionisation of the Amazon workforce has become a bigger issue in recent years with increasing protests and strikes. Workers claim the company is conducting a crackdown.
We think investors will increasingly steer clear of firms with a reputation of poor working practices. This could present a big cultural challenge given the increased size of the business.
The jewel in the crown which is growing fastest is the cloud computing Amazon Web Services operation. While it generates strong margins there is significant competition in this market from other well-resourced players. Amazon is a rare example of a big tech company where earnings have actually grown faster than the share price – reflecting how the company’s profit has increased from a low base.
We think sentiment will remain poor towards Amazon in the near-term so avoid the shares. [MG]
APPLE (AAPL:NASDAQ) $133.49
THREE AREAS TROUBLING INVESTORS
Concern over disruption to supply chains
Demand for expensive consumer electronics could suffer in a recession
The iPhone may have reached saturation point
Electronics firm Apple (AAPL:NASDAQ) is one of the great success stories of the last quarter-century, having developed its own complex ‘eco-system’ with more than 900 million customers owning its devices.
It has a high customer retention rate, and while demand in the US and Europe may be close to peaking there is still a huge addressable market in countries like China and India.
In China, Apple sold 333 million iPhones in 2021, whereas in India, a nation of 1.2 billion people, it sold less than five million units.
Supply disruptions could negatively impact iPhone sales for the next two quarters but the firm is pushing to produce its own chips within a few years, as it has for its Mac computers, and its own screens.
The iPhone still accounts for more than half of Apple’s revenues, which topped $394 billion last year, and as a premium product there may be doubts over whether cash-strapped consumers will fork out for something which is nice-to-have rather than must-have.
After losing nearly $850 billion in market value last year, Apple shares now trade on 21 times forecast earnings for the current financial year compared with 48 times 2020 earnings.
Revenue growth from services such as Apple TV, iTunes, the App Store and Apple Pay is running at more than 50%, with a gross margin of around 70% or double that of product sales.
By the end of September 2023, the company’s net cash pile is forecast to be $47.89 billion, supporting dividends and share buybacks which together amounted to more than $100 billion last year. A 654% total return in Apple shares on a 10-year view, ahead of a still impressive 287% increase in earnings per share over the same time period, shows how the company’s qualities have become more highly prized by the market.
On balance, the shares are worth buying at the current price. [IC]
META PLATFORMS (META:NASDAQ) $132.99
THREE AREAS TROUBLING INVESTORS
Lack of belief in the metaverse strategy and leadership concerns
Falling advertising revenue
Tighter privacy regulations
The renaming of Facebook to Meta Platforms (META:NASDAQ) in October 2021 was meant to signal a bold reimagining of the business to position it for the growth of the metaverse – a series of interconnected worlds that enable participants to interact with digital objects and avatars.
This strategy has encountered scepticism. Terry Smith suggested in his latest letter to investors of the Fundsmith Equity Fund that Meta should ditch its metaverse spend. If it did, Smith said Fundsmith would be left owning a stake in a ‘leading communications and digital advertising business on a single-figure price to earnings ratio.’
Meta is extremely unlikely to give up on the metaverse entirely but even signs of a more sober approach to spending in this area would be welcomed by shareholders. It could also help address concerns over founder Mark Zuckerberg’s leadership of the company which have intensified since the departure last year of chief operating officer Sheryl Sandberg, seen as the ‘grown-up in the room’ by many investors.
Meta’s Facebook and Instagram platforms remain obvious destinations for advertisers, but the company’s advertising revenue has proved far from immune from an economic downturn, down 4% year-on-year in the third quarter of 2022 to $27.2 billion.
In response to these figures, market research outfit Insider Intelligence cut its 2023 forecast for advertising revenue from $148.1 billion to $121.9 billion.
Pressures on personalised adverts, one of Meta’s key selling points for investors, are only likely to increase as regulatory scrutiny around privacy issues builds.
When you add all these issues together, the investment case is no longer compelling and so we do not believe the shares are worth owning.
The downward trajectory in Meta’s share price has resulted in a negative total return on a five-year view. Over 10 years the return from capital gains and dividends of 319% pales in comparison to a 2,471.9% increase in earnings per share. For context, a decade ago the business was taking its first baby steps into profitability. [TS]
MICROSOFT (MSFT:NASDAQ) $235.77
THREE AREAS TROUBLING INVESTORS
Will Activision Blizzard buyout happen, and will it be worth it?
How will big job cuts impact its core Office 365 demand?
Impact of strong dollar on revenue and profit
Microsoft has never been afraid to take risks with big acquisitions but its $68.7 billion pitch to buy Call of Duty, World of Warcraft and Candy Crush owner Activision Blizzard (ATVI:NASDAQ) represents its biggest gamble yet.
The tie-up is far from guaranteed to happen, with regulators in the US, EU and UK scrutinising the small print, but if it does, there is plenty of outstanding engineering talent at Microsoft capable of bringing extra value to the gaming space.
But beyond this, with its own expertise in the fledgling metaverse, Microsoft would be able to create a ‘multi-faceted metaverse of gaming and wider entertainment with a good chance of becoming a leader in this new field,’ says Gerrit Smit, manager of the Stonehage Fleming Global Best Ideas Equity Fund (BCLYMF3), where Microsoft is its second largest stake.
In October, Microsoft beat expectations but reported its slowest revenue growth in five years and rising energy costs and the strength of the US dollar cut away profits. Sales growth in its Azure cloud business – one of the company’s growth bright spots in recent years – was lower than analysts had hoped at 35%. Azure’s revenue is largely driven by consumption, meaning that it rises as customers use the cloud offerings more, so large-scale global job cuts could be a worry.
In 2022 Microsoft announced Office 365 subscription price hikes of about 15% to 20%, which illustrates how robust this company is. Enterprises simply can’t run with Outlook, PowerPoint, Excel, Teams and more, and it’s almost unthinkable to consider alternatives, believes Blue Whale Growth Fund’s (BD6PG78) Stephen Yiu. We agree. Over the last decade Microsoft’s earnings have increased 272.3% but its shares have delivered a total return of more than 800% as perception around the stock has moved away from seeing it as tied to a structurally declining desktop PC market. [SF]
DISCLAIMER: Steven Frazer has a personal investment in Blue Whale Growth Fund.
NETFLIX (NFLX:NASDAQ) $327.54
THREE AREAS TROUBLING INVESTORS
Slowing subscriber growth
Rumoured poor take-up of new advertising-supported service
Cost of new programming
This year could be make or break for streaming giant Netflix (NFLX:NASDAQ) as we discover if its less expensive advertising-supported service can help revive subscriber growth and protect the company from the risk of mounting cancellations by hard-pressed households.
Netflix cannot afford to maintain its previously relaxed stance on password sharing – however, having turned a blind eye in the past, it risks alienating customers if it now adopts too draconian an approach.
News of the new advertising tier helped drive a recovery in the share price in the second half of 2022 but specialist publication Digiday said in mid-December that audiences for the service had fallen short of the numbers Netflix had promised to advertisers. Quoting executives from five advertising agencies it suggested Netflix was having to offer refunds. Netflix’s latest quarterly update was scheduled to come out today (19 January) and should provide some insight.
As well as this cheaper alternative subscription tier, Netflix will need to demonstrate it can push through price increases for its other subscription plans to help protect profitability. Forecasts for 2023 suggest the company will offer very modest earnings growth and yet the shares trade on a price to earnings ratio of 31 times which seems too high.
A more disciplined approach to content spending is necessary, with the company expecting to keep its budget steady at $17 billion. That could be a double-edged sword for the business. Unlike rivals like Disney (DIS:NYSE) and Paramount it doesn’t have a large library of popular historic content it can fall back on.
Also, it doesn’t offer live sport in the same way that Amazon (AMZN:NASDAQ) does through its Prime Video platform. This could make it vulnerable to customers looking elsewhere for their viewing needs.
Over the last five years the company has moved from a position of very modest profitability, reflected in its 2,514% increase in earnings per share but its shares have not kept pace with a 48% total return. [TS]
TESLA (TSLA:NASDAQ) $123.22
THREE AREAS TROUBLING INVESTORS
Concerns that founder and CEO Elon Musk is distracted by Twitter
Demand could slow because big ticket purchases are vulnerable in a downturn
Mounting competition from EV specialists and traditional car manufacturers
From a current level of around 20 million, the IEA (International Energy Agency) estimates the global ‘park’ of electric vehicles will grow 18% per year to reach 350 million by 2030, making the market worth over $800 billion.
While deliveries last quarter may have marginally undershot its target, Tesla (TSLA:NASDAQ) is still the leading EV maker, but to maintain its pole position it needs to overcome supply bottlenecks, manage higher input prices and satisfy customer demand.
Competition is heating up and Shenzhen-based BYD (1211:HKG) has emerged as a serious contender thanks to its vertical integration which includes batteries, motors and chips.
After outselling Tesla in the Chinese market, BYD is now expanding production and sales and is aiming for four million units this year.
In terms of valuation, Elon Musk’s lack of leadership, as he sells shares to fund his Twitter takeover and continues his increasingly erratic leadership of the social media platform, has seriously damaged the share price as well as the firm’s brand equity and needs to be addressed.
As the Toronto Star recently put it, ‘if Tesla once seemed like the future of everything, a company led by a visionary that would usher in a new era of clean energy, it now seems like merely another car company, hardly “failing”, but ordinary just the same’.
In that scenario, even after losing over $700 billion last year the current market value of $380 billion still seems too high. Over the long term the shares have delivered strong returns – the 10-year total return totalling 5,520% [IC]
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