By Cary Springfield, International Banker
On July 19, the US technology sector marked a momentous occasion. Thanks largely to an improved economic outlook and greater optimism over its constituents’ earnings, the S&P 500 Information Technology index hit a 17-year high of 992.29, and thus eclipsed the previous peak attained during the midst of the dotcom era. The event provides just one of the many clear indications of how hot the technology sector is at present.
In addition to being the largest allocated sector in the S&P 500, technology has been the best performer within the benchmark US equity index so far in 2017. The Technology Select Sector SPDR ETF (XLK), which is among the most popular and best-performing technology-sector funds, for instance, has gained around 20 percent to date, easily outperforming the SPDR S&P 500 ETF (SPY), which has gained 11 percent during the same period. XLK’s growth can be credited in no small part to the inclusion of big hitters Apple, Microsoft, Facebook and Alphabet, all of which are having bumper years with respect to earnings growth. Apple, for example, posted its earnings report at the beginning of August for the most recent quarter, and did not disappoint. The California-based tech giant recorded earnings per share (EPS) at $1.67, which beat analyst expectations of $1.57. On an annual basis, moreover, Apple’s EPS increased by almost 17 percent. Facebook, meanwhile, posted its quarterly earnings report at the end of July; again, its EPS of $1.32 beat the consensus estimate of $1.13, while it recorded a remarkable 36 percent rise year-on-year. Of the 73 stocks that make up the XLK fund, the four tech giants comprise an approximate 43.5 percent weighting.
Indeed, the startling growth of the technology sector has been a story almost entirely of the industry leaders. The “Big Five”—the aforementioned four, plus Amazon—have seen their aggregate market capitalisation increase by more than $625 billion this year, equivalent to a hefty 27 percent gain. It has become patently clear that these five behemoths hold significant advantages over their rivals, which is helping them to drive the technology sector and US equities to new all-time highs. According to PwC’s 2017 Technology Trends study, there are four key factors that have enabled the Big Five to keep building on their successes:
Platform strength: The past decade has seen all five companies build successful businesses on ubiquitous platforms and business ecosystems. This has helped them to achieve unparalleled levels of enterprise value, revenue, profits and cash flow. While the next 20 companies have seen their revenues contract over the last six years, the Big Five have generated revenue growth of $287 billion. Even more impressive is the $1.5 trillion of enterprise value they created during this period, around three times as much as the next 20.
Innovation reinvestment: The Big Five consistently reinvest profits, with a sizeable portion going into research and development (R&D). Since 2011, they have collectively averaged $44 billion per year, and last year accounted for five of the top 11 R&D spenders across all industries. Alphabet, Amazon and Microsoft are now reaping the rewards, with public cloud infrastructure being a standout profit generator. Amazon’s returns are particularly laudable, given that they had no footprint in this space prior to 2006; and yet 10 years later it has managed to capture easily the biggest share of the corporate cloud-computing business.
Acquisitions: Alphabet, Apple and Microsoft are particularly prolific acquirers of smaller companies, but all five have proven to have made shrewd acquisitions in recent years. They have focused mostly on small to midsized companies that can enhance their existing capabilities in such fields as artificial intelligence, machine learning, virtual reality and augmented reality. Google, for instance, has acquired more than 10 artificial-intelligence start-ups during the last five years, according to research from CB Insights.
Talent attraction: The Big Five continue to make hiring a distinct priority in order to support new product development and capital deployment. While the next 20 tech companies have shed more than 40,000 net jobs since 2011, the Big Five have added more than 418,000 net jobs. While the competition for the best tech talent is fierce, job-seekers are well aware that time spent at one of the Big Five dramatically improves their career prospects.
Looking forward, the Big Five are expected to continue growing at a solid rate, particularly by investing in innovations and new businesses. Indeed, PwC (Pricewaterhouse Coopers) expects them to remain dominant in their own fields of expertise, which include “high-end devices, digital content distribution and app stores, online search and advertising, social media, e-commerce, cloud services, and productivity software”, while also branching out into new businesses. Moreover, they will continue to have a competitive advantage in doing so, namely “positive network effects inherent in their hyper-scale platform businesses, formidable innovation capabilities, and massive financial muscle”.
As such, it perhaps comes as no surprise that many of the best-performing technology ETFs (exchange-traded funds)—and the ones with the brightest outlooks—are heavily weighted towards the Big Five and other tech leaders from around the world. That said, one of the very best-performing funds of the year is the ARK Innovation ETF (ARKK), which is up by 44 percent year-to-date and focuses on some of the most interesting emerging technologies around, including 3D printing, cloud computing, autonomous cars, genomics and blockchain. In terms of individual tech stocks, meanwhile, the video-game giant Activision Blizzard is among the biggest gainers of the year. With the gaming industry growing by around 16 percent per year, according to estimates from Mark Tepper of independent wealth-management firm Strategic Wealth Partners, it is now proving to be a particularly lucrative draw for investors.
Will technology continue to dominate? Given the positive projections for the Big Five, it would appear so. Owing to their size, culture of innovation, insatiable appetite for acquisitions and investments in research, it is strongly likely that the tech giants have the capability to continue innovating and leading the market for some time yet.