Misconceptions and Truths of Investing in Tech Stocks (Part 1)
by Patrick Oberhaensli, on Nov 9, 2020 2:31:00 PM
Since March 2020, we have seen record breaking numbers within investments in the big tech industry. This current hype surrounding a handful of mega-caps from the (high)-tech sector, serves as the perfect backdrop to kick-start our series of four articles dedicated to investing in technology stocks. In the first two articles, we will address a series of misconceptions (there are many!) and realities surrounding investing in these tech stock investing. Here is the first part…
The Year 2000 Tech Crash
After the tech crash in 2000, the related large indices would not get back to their highest for a very long time or even never! That was the story…
Well, despite the fact that NASDAQ had reached an absolute high in the Spring 2000 before massively crashing, it actually made a new record high already in 2015. That period even included the Great Financial Crisis from 2007-2009 which lead to another crash of the main indices!
In other words, it didn’t take a very long time for NASDAQ to bounce back and the reason for this is very simple. Such a large index – it currently includes more than 3’300 stocks where not all are tech related but the majority are - will exclude too much weakening/disappearing companies while new strong companies are included. This has a lot to do with the technology cycle, meaning "progress (with efficiency gains for example) and which has a clear accelerating movement. Ultimately, it favors passive ETF investing for the (very) long-term.
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The Mega-Cap Effect: Is it really good?
The year 2020 has proven that a handful of mega-cap stocks can disproportionately drive up the price of main indices in which these stocks are included. Clearly, we’re not talking about large-caps and mid-caps and certainly not small-caps. In addition, that massive push move can dramatically increase in speed. In that context, (very) high media exposure of these stocks likely plays a key role by attracting speculators with a more or less strong background.
Tesla’s market capitalization has been multiplied by close to 7 between its low in March and its highest closing on August 31st (as of the 14th of September, the absolute highest occurred on the very next day). The market capitalization flirted with the $500 bn USD while at the same time, Tesla's core activity remains quite small versus that of its same-sector competitors who are valued at much less.
Apple, which was the first company ever to have reached a market capitalization of more than 2 trillion USD, can be compared in size to that of the total market capitalization of key indices of European exchanges. This implies a tremendous if not incomparable future development of its (innovative) activities: Is it even likely? Not to mention, there are still material risks in the economies of both developed and emerging markets and the prpensity to consume is relatively smaller. In comparison, Apple can easily in a single daily see a price change that goes well beyond twice the (total) market capitalization of UBS! And in both directions, at that!
Then came the capital increase for Tesla of up to $5 bn USD which kick-started a down-move well beyond the Tesla stock. On top of that, the news on Friday September 4th that Tesla wouldn't be included in the S&P500, had a significantly negative impact on after-hours trading and lead to an even larger loss on the next trading day (September 8th 2020). It should be noted that a stock isn't automatically included in the S&P500 but instead an ad-hoc committee makes the decision – that process is often not well understood. In other words, the tech index/indices endured sharp losses in these days.
An essential aspect when examining the behavior of mega-cap stocks, is their weight within the (mainly cap-weighted-) indices. This weight can lead to a momentous dynamic on their own in which the other stocks play a secondary role (as they are not necessarily making new highs at the same time). This happens automatically when investors buy index ETFs of key large cap indices since a large part of the monies go to... the mega-caps. That kind of passive “no valuation questioning” allocation has a (strong) tendency to increase – in both market share and volume.
In this first part of our article series examining tech stocks, we addressed one of the most common misconceptions of a largely diversified tech index. We clearly see it's wrong to assume that the index won't make a comeback after a tech-burst. In fact, simply by its design and construct, the index will make a new record high sooner rather than later. Moreover, the mega-caps can in some periods be so dominant that it gets contra-productive: the investor should be aware of that especially when there is an acceleration of the rally. In the second part of this article, we will provide a detailed comparison with value stocks and the high Price/Earnings ratio.
EVOLIDS FINANCE LLC, Disclaimer:
- This content is not intended to be a solicitation nor an offer
- The preparation of the information provided herein is done with a high level of care. Nevertheless, errors are possible