Tech stocks may be riding on record highs, with sky-high valuations, but investors shouldn’t fear another Dotcom Bubble crash, according to Terry Smith.
Terry Smith is a well-known fund manager in the UK, and has been called “the new Warren Buffet.” Smith’s fund is heavily invested in tech stocks, leading to some concern that he’s vulnerable to another Dotcom Bubble crash. In a letter to investors (PDF), Smith addresses those concerns and explains why he doesn’t believe tech stocks are in jeopardy.
One of the biggest factors Smith points to is how differently tech stocks, which often have intangible factors, must be evaluated. In so doing, he points out an inherent advantage of tech companies, whose trade is more often than not in information and intellectual capital.
The main assets of the companies we seek to invest in are often intangible. Some examples of intangible assets are brands, copyrights, patents, know-how, installed bases of equipment which require servicing and maintenance and so produce customers who are locked-in to the supplier, software systems which are critical to a business or person and so-called network effects. They are distinct from tangible assets such as real estate, machinery and equipment, and vehicles.
The return on intangible assets is higher as they mostly need to be funded with equity not debt and attract an appropriate return. Lenders seem to crave the often false security of lending against tangible collateral. Intangible assets can also last indefinitely if they are well maintained by advertising, marketing, innovation and product development and the duration of an asset is an important factor in figuring out its real returns.
Interestingly, Smith also makes the case that COVID is setting up for some specific growth trends. Like many, he likens the current pandemic to the Spanish Flu, and draws a comparison to Henry Ford and the Model T.
The assembly line was not invented as a result of the Spanish Flu pandemic — the Model T Ford was put on an assembly line in 1913 — but it accelerated its adoption.
The increase in productivity this delivered helped to fuel an economic boom as the cost of production of items such as cars and household electrical appliances were reduced as the volume of production rose so that they became affordable by the middle classes for the first time. This helped to fuel the economic and stock market boom of the Roaring Twenties.
Smith sees the possibility of something similar happening post-COVID as a result of remote work and digital communication becoming normalized. Salesmen will be able to meet with more clients virtually than they could in person, businesses will see reduced costs, factories will be able to maintain production despite using less staff and more.
Obviously, as he points out, it’s not good news for all industries.
Of course not all businesses benefit from these developments. The airline industry, hospitality, bricks & mortar retailing and office property may all have some very difficult problems to face, just as you wouldn’t have wanted to have been a saddler when Henry Ford and his competitors hit their stride.
This analogy helps explain why Smith’s fund is so heavily invested in tech and why he’s not worried about a possible crash. Of course, as he humorously points out, no one’s predictions are perfect.
I will leave you with this thought: What are the similarities between a forecaster and a one-eyed javelin thrower? Answer: Neither is likely to be very accurate but they are typically good at keeping the attention of the audience.