The US government just took a bite out of the FANGs. Following the serious privacy concerns raised at Facebook, it is now squarely in the sights of the government as is the rest of the industry. Amazon has Trump’s attention given his tweets citing disruption of mom and pop retailers and the view that they do not pay enough in taxes. More is sure to come. Technology has been a focus of attention for policy makers for some time given the influence it has over a broad swath of the economy. This dates back to the early days of the incoming Trump administration regarding visa policies (technology is a large user of the HB1 program) and corporate taxation (technology used offshore licensing and other techniques creating a lower effective corporate tax rate than most industries). This is a shift from the prior administration where corporate tech leaders were embraced and lionized. Billions of dollars of market cap have been erased as prices across the sector slide in a market that is jittery enough to sell first and ask questions later.
We believe recent stock action in the sector is only the beginning of increased scrutiny as technology companies are victims of their own (growing) success. As policy makers and consumers awaken to the practices of these influential companies, there is likely to be differentiation between those who are good corporate citizens versus those that are not. Scrutiny will also likely rise on the fundamentals.
There is a difference between a great innovation, a great company, and a great stock. A great innovation can change the direction of industry, but the first mover is not necessarily the winner or the most profitable. Tesla has brought tremendous change in the automotive industry and captured the consumer’s imagination for electric vehicles, though it is yet to ever turn a profit, hit a production goal, and has junk debt trading at 86 cents on the dollar. A great company can execute on an idea whether they came up with it or not. Remember that Microsoft which was a category-killer in its day (and is still a large and thriving business) did not come up with the idea of a spreadsheet, a word processor, or a presentation builder. They just packaged and sold it better. A great stock is a company that has solid fundamentals but trades at a price where it can exceed expectations. With P/E multiples in the triple digits for a company like Netflix there is the question of whether it can deliver profitability to meet the hurdle set for it.
As portfolio managers, we must also be mindful of the level of technology exposure across our investments. Technology is near 25% of the S&P 500 index with the FANG stocks alone representing 9% of the index. According to Strategas Research, 44% of equity assets are in index-based investments so unwitting investors may not recognize how much exposure they have. In addition, many active managers also own the FANG stocks. Given their weight and contribution to index performance these past few years, these managers faced the career risk of either getting onboard or falling behind. That in and of itself creates a positive feedback loop pushing more capital to fewer holdings. We believe sometimes you have to be willing to fall behind the “benchmark” for a while to make sure your investments are appropriately diversified and avoid getting bit.