There is actually no harm in thinking that trees grow to space and beyond…in reality they don’t. Same with the valuation of tech companies. At a price-to-earnings ratio of 42x for US tech companies, huge expectations are built in.
Granted, the post-pandemic world is beneficial to everything that is digital. The future will need more screen time, bandwidth, microchips, digital platforms, online services and so on. In short, it’s gonna work well if your business model is somewhat aligned with this trend.
Valuations in general are also boosted by the abundance of money, and very low rates. As a good honest-to-god saver, the perspective of getting your low-risk returns trashed pushes you to the hill, that is to say higher risk-return that you typically obtain with companies that have a BIG promising agenda. After the Mar20 market meltdown, the first reaction of squirrelling money away – US saving rate was at a historic high of 17% – quickly subsided to aggressive risk taking. ArkFunds, which seeks companies with “disruptive innovation”, saw their fund rise 200% since the Mar20 and has collected $8.6bn year-to-date. This is nothing short of eye-watering.
However, there is a point where the extra notch of risk you take does not justify the future return you get. Putting aside that the market could be irrational longer than you can remain solvent (Keynes), there comes a moment where some companies can’t deliver on the foolish expectations that have been laid upon them.
We argue that the exponential rise in tech-themed stocks has some roots in the way these are bundled through funds, and we would raise caution on any investment theme that is not paying attention to the fundamentals of what it owns. But again, you should be fine if you’re diversified across sectors and asset classes. Give us a call if you need help on that.
360 Advisory – Markets