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Edition 8 - Technology insights

Why we’re investing in tech stocks this decade

Markets moving into freefall during COVID-19 has compounded a truth of the 2020s for investors: technology bears a far greater influence on societal functioning and our portfolios than it ever has. We spoke to portfolio manager in the global equities team, Andy Gardner, about the trends he’s backing for the coming decade.

An enormous leap forward in global communications. The inexpensive replication of information and news. Ideas that spread around the world. The democratisation of thought.

No, not the internet. The printing press, invented some 500 years earlier.

Our rapid adoption of communications technology, smart phones and cloud computing are just the latest in a long line of technological advances that have swept through history.

In fact, the world has undergone a technology revolution every 40 to 60 years since the industrial revolution began in 17711, from steam power and railways to steel and electricity to cars, roads and aviation.

Each revolution brought sweeping economic and technological change. They spawned new business models and created waves of new entrepreneurs. They also displaced old industries, triggered speculative bubbles and sometimes brought social and political upheaval.

Still, the impact of the information communications technology revolution is arguably the greatest ever.

And one thing in particular is undeniable: technology bears a far greater influence on our daily lives and investment portfolios than it ever has.

This impact can be seen in the disproportionate success of companies, individuals and investors that have embraced technology compared to those who are yet to do so.

But what happens next in the story of technology and revolution? And how can investors navigate things as we enter the 2020s?

The global equities team at AMP Capital has developed a ‘wealth creation framework’ that captures the characteristics that enable companies the best possible chance of compounding cash flows at a higher rate and with a more stable trajectory.

The foundation of the framework is the idea that disruption is not new, but has in fact been a feature of the economy for centuries.

The team remind themselves of Jeff Bezos’ famous statement, that seeking to understand what will change in future is almost never as important as seeking to understand what will remain the same.

“What Jeff is saying is that business strategy should focus on goals which are eternal truths regardless of which technology or trend comes by along the way,” says Gardner.

The AMP Capital global equities wealth creation framework has four factors
  1. Competitive advantage: a company must have an edge over the competition that will stand the test of time, from pricing power to intellectual property.
  2. Runways for growth: a company must benefit from enduring growth tailwinds that won’t be held up by market cycles.
  3. Capital allocation: capital discipline and good governance is very important to wealth creation as it takes skill and commitment to reinvest wisely for the long-term benefit of the business and shareholders, whether that be to reinforce the competitive advantage or give back to shareholders.
  4. Predictability: a company must demonstrate stable cashflows that can reliably and persistently create wealth over a long period of time.

“The most important requirement of all is to generate high and sustainable returns on capital over a long time frame,” says Gardner.

“We believe that when all these components align with a structural tailwind to growth, then the magic of compounding occurs, and a genuinely great investment is unlocked.”

The framework has helped identify a number of areas of investment within the technology sector for the AMP Capital team to focus on.

First, enterprise technology is preferred to consumer technology. In general, enterprise technology has greater barriers to entry and exit, longer and more predictable product cycles and lower regulatory risk.

“It’s also increasingly moving towards a recurring revenue model, which helps improve the stability of cashflows,” says Gardner.

“In contrast, consumers tend to be incredibly fickle, more transactional in their relationship, and commonly switch from one brand or fad to another.”

He says that switching has long been a feature of consumer hardware. People swap cameras and TVs as new technology emerges has now become a feature of consumer applications, such as content, social media and gaming, as our attention moves skittishly from, for example, Facebook to YouTube to Spotify to Instagram to TikTok to Netflix and so on.

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Second, software is favoured over hardware.

“We estimate that software now captures close to 40 per cent of revenue dollars, compared to just five per cent in 1980,” says Gardner.

“And there is still a substantial amount of revenue that is still to shift.”

Higher rates of growth and margins are in part attributable to the low marginal costs associated with software growth, along with its rapid scalability, and its pervasiveness as it begins to permeate nearly all industries.

Indeed, it is difficult to see growth flagging for big tech as they have a long runway ahead of them. Gardner outlines three areas in particular that he sees will continue to account for most of the growth.

The first is digital advertising, which is estimated about 50 per cent penetrated today and growing at 15 to 20 per cent a year. Over the next four to five years though, digital advertising should begin to mature and account for 70 per cent of the advertising market.

The second is ecommerce – and it’s an even bigger opportunity.

E-commerce, the activity of buying and selling over the internet, represents just 10 per cent of commerce today and has the potential to reach 30 per cent by the end of the decade, growing at around 10-15 per cent a year.

It’s a huge prize but potentially a slower burn given the physical investments required in distribution centres and delivery.

The third opportunity – cloud computing – is possibly the biggest and fastest growing of the three.

Cloud computing is the provision of data storage and computing power over the internet. Cloud computing is estimated to account for 25 per cent of the market for enterprise IT workflows, with potential to reach 70 per cent penetration by the end of the current decade. Cloud is growing at 20 to 25 per cent per annum.

“Cloud, and the software applications which are built on top, are likely to be the biggest drivers of profit-pool shifts within the technology sector itself, taking share of wallet away from spending on hardware,” says Gardner.

We believe that when all these components align with a structural tailwind to growth, then the magic of compounding occurs, and a genuinely great investment is unlocked.”

The outlook for big technology is not entirely free from risk of course. Some technological advances are pushing the limits of regulation, especially in privacy, while some technology companies are running up against competition and anti-trust limitations.

While the big technology companies and trends are quite exciting, they are generally quite well understood by investors.

In contrast, the AMP Capital global equities team prefer to participate in a number of trends and companies that are not well represented in the indexes.

Examples include the increasing application of simulation technologies in the production and maintenance of industrial and consumer products, or the mission-critical software used in the design, development and verification of increasingly complex semiconductor chips.

They also believe that some of the most attractive areas for investment are in technology companies that sit outside the traditional sector-classification standards. Healthcare is a great example of this.

Healthcare has been slower than many industries to adopt technology, partly because it deals with a high regulatory burden.

Gardner highlights the difference between the rising cost of healthcare and the falling prices of white goods, clothing and cars as examples of the uneven distribution of the productivity dividend of technology.

“On a like-for-like basis, the cost of a TV has fallen a whopping 97 per cent since 1998. You get substantially more now, for less,” he says.

“But healthcare is over 225 per cent more expensive.”

Now, as healthcare’s adoption of technology gathers pace, society could be set to reap the greatest dividends yet from technology and innovation.

While many fear jobs being replaced by automation, Gardner expects 'augmentation' – the confluence of data and technology combining with human work – to shape the future.

“Ultimately, we want the highest-quality medical decisions being made as accurately and efficiently as possible,” he says.

“Capturing all medical records electronically will allow patient histories, test results, and relevant information to be available for analysis. Applying big data and machine learning to these data sets will enable a patient to compare their specific condition more precisely to thousands - if not millions - of other patients who have experienced the condition before, allowing more accurate and precise treatment."

 

“It will also allow for changing roles, enabling the nursing workforce to be more effective in frontline delivery and providing physical and emotional assistance to patients, and gives highly trained, and higher cost, GPs, doctors, and physicians the time to focus on more complex and specialised care needs where their impact can be greatest.”

One of the key applications that the team is excited about is robotic surgery, which today accounts for less than two per cent of all surgical procedures. Robot-assisted minimally invasive surgery can result in better working conditions for the surgeon, reduced blood loss, lower complications, reduced length of stay, and quicker recoveries.

As compounded by the home schooling enforced by COVID-19, education is another industry with potential. As it stands, higher-education costs are 183 per cent higher than 20 years ago – and textbook prices are up 150 per cent – again indicating that digital technology has not yet lifted productivity.

“The concept of a teacher standing in front of a room full of students – all of the same age, who are forced to listen and respond to direction, at the same time and pace, seven hours a day, five days a week, for 12-plus years – is being turned on its head,” says Gardner.

“Customised and collaborative learning, which can be done almost anywhere and anytime, enabled by technology are some of the ways in which education is set to change in the coming decade.”

Within the industrial economy, robotics and automation offer the biggest potential for change.

Automation is of course common in many industries. But the confluence today of sensors, machine vision and artificial intelligence are suddenly offering great leaps in capability, from warehouses enabling companies to pick, pack, and ship products for ecommerce and to the ‘Internet of Things’.

The ‘Internet of Things’ – already known to millions by the acronym IoT – is the emerging combination of sensors and internet-enabled devices. By the end of the decade, there could be 500 billion connectable devices up from 30 billion today2.

“All of this will be wrapped up and connected by software which provides the glue that sticks it all together,” Gardner says.

“Most intriguingly, it will become both ubiquitous yet largely invisible – it will be ‘always on’, operating in the background, constantly gathering data and making decisions on our behalves.”

One thing is certain as we move through the 2020s: delivering strong, risk-adjusted returns will require a targeted approach.

Attractive returns will be found in specific technologies and industry verticals that are different to the growth drivers of the last decade.

And above all, individual company fundamentals will matter more than ever.

You can read more in Andy Gardner’s whitepaper, Tech in the 2020s.

1 Carlota Perez, full reference and more information in 'Tech in the 2020s' whitepaper, Andy Gardner, AMP Capital
2 Cisco, full reference and more information in 'Tech in the 2020s' whitepaper, Andy Gardner, AMP Capital

Important Notes

While every care has been taken in the preparation of these articles, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty as to the accuracy or completeness of any statement in them including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. Performance goals are merely goals. There is no guarantee that the strategy will achieve that level of performance. The information in this document contains statements that are the author’s beliefs and/or opinions. Any beliefs and/or opinions shared are as at the date shown and are subject to change without notice. These articles have been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. They should not be construed as investment advice or investment recommendations. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

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