Tech stocks fly due to pandemic

Tech stocks pandemic COVID-19 technology

If there is one big trend that has emerged through the COVID-19 pandemic it is the rapid acceleration of technology which has resulted in an unprecedented investment boom.

If you own shares in the big technology companies, this has been one of the really great booms to be part of.

If instead you own lots of shares in threatened industries such as shopping malls, traditional retail, travel, hotel and airline stocks, you could be forgiven for thinking you were living through a total bust.

Adoption of technology rising fast

It has been one of the starkest contrasts of all time as the pandemic really brought forward the use of technology for everything from accounting and online shopping all the way through to video streaming and video conferencing.

At the same time as this trend was emerging to push technology stocks to new highs, many old industries that had been hit hard by the COVID-19 shutdowns as people reduced their reliance on high contact activities like shopping and working in hot desking offices.

Old school companies fall by the wayside

International and even interstate air travel have taken a massive hit and it seems unlikely that the old model of flying people around the country and internationally for people to stay in hotels and attend meetings will return to anything like its former volume soon, if ever.

The same goes to some extent for tourism which seems unlikely to return to old patterns, with cruises the most obvious casualties for what looks likely to be a protracted time.

Global tech stocks pushing the entire market higher

Since the stock market’s initial lows as the damage from the pandemic became obvious in late March, the US index for the S&P 500 (which includes most of the large-cap tech stocks) has risen 46% while the more technology-specific NASDAQ has climbed 56% in the latest surge.

For the more concentrated “FAANG+” stocks – which includes Facebook, Apple, Amazon, Netflix, Google and other technology companies such as Tesla – the rise was 83% before the recent weakness.

It is not just a hot trend that we are seeing here – there is genuine wealth being generated by the technology sector, even if not all of the rise can be immediately justified.

Profits changing fast

A report by global management consultancy company McKinsey found that profits are changing along with perceptions.

“Industries and companies that started at the top of the curve before this crisis are proving to be resilient, while those that were at the bottom are accruing the biggest losses,” McKinsey found.

“Sectors that were at the top of the curve before the crisis, such as pharmaceuticals and semiconductors, seem to be pulling ahead from the less profitable industries that started at the bottom, such as banks and utilities.

“In fact, the six most-profitable industries have added US$275 billion a year to their expected economic-profit pool, while the bottom six have lost US$373 billion.”

That is a stark contrast in ongoing profitability.

Scalability gives tech companies a big advantage

There is also some valuation justification in backing successful technology stocks due to their spectacular ability to scale up profits once the original product costs have been paid for.

A given piece of software or streaming movie costs the same to produce if one person is using it or 20 million people.

Although the figures are a little old now, Netflix was producing revenue of $3.3 million per employee for the 2019 financial year.

Revenue per employee shows the potential

It is not alone with some of the other tech titans outperforming such as Apple ($2.7 million of revenue per employee), Facebook ($2.2 million), Google owner Alphabet ($1.9 million) and ebay ($1.1 million).

Most of those numbers are sure to have increased since then as the tech giants can grow globally and within national markets at very small extra cost, with much of the increased revenue falling straight to the bottom line as profit.

As McKinsey put it: “The crisis has accelerated a trend that was already present.’’

Central banks also pushing stock prices higher

Another factor that is pushing up technology valuations is the highly unusual policies of the world’s central banks, which are pumping enormous amounts of liquidity into markets and keeping interest rates extremely low.

That has the effect of pushing growth companies harder than those that show value because it reduces the risk-free rate of return to very close to zero.

Investors are pushed to take more risks and stocks that promise growing returns become ever more valuable in an environment in which any growth is seen as much more preferable to the almost zero returns available for cash.

Risks to that growth tend to be downplayed or ignored entirely as the large amounts of liquidity being produced by central banks find a new home.

Investors are happy to even accept lower returns for greater risks because they have no positively real-returning alternatives.

In this environment technology companies have an inbuilt advantage due to the high scalability of their business models compared to traditional companies that must generate profits from fixed assets.

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