For many investors, large cap technology companies are seen as a large monolith. Collectively referred to as “Big Tech”, these companies are some of the largest index constituents and generate over $1 trillion in revenue. While they are often lumped together, it is important to recognise the unique drivers of each of these companies. Instead of simply buying or selling a company because it is labelled a Tech Company, it is essential to determine if this is indeed the case.
A key factor for every company is its sensitivity to the economic cycle. No one is immune to economic downturns, but some are more vulnerable than others. Investors generally classify companies as cyclical and non-cyclical companies when looking at their sensitivity to the economic cycle. Cyclical means they are more sensitive and non-cyclical means they are less sensitive.
Within the technology space, a similar distinction needs to be made. A significant portion of Big Tech revenue is generated from advertising (think Google, Facebook and to some extent, Amazon). While the delivery of these ads is digital, the product being delivered is identical to those offered by legacy advertising. In both instances sellers are trying to convince buyers to buy products - the only difference is the medium.
Advertising and marketing are generally the first budgets to be slashed as the economic cycle turns. Consumers buy less stuff and the willingness to spend on advertising falls as well. When digital advertising was in its infancy it was somewhat immune to the overall cycle as there was significant market share to be taken from legacy advertisers. But this has changed as digital advertising has matured and the market is saturated with advertising platforms. Many of these companies are, for the first time, experiencing the effects of marketing and advertising budget cuts.
While Google and Facebook (as well as other digital advertising platforms) may be classified as technology stocks, ultimately, they need to be viewed as cyclical businesses subject to the same issues affecting other cyclical industries. It is true that Google and Facebook (as well as other digital advertising platforms) have been facing company specific challenges – ranging from Apple privacy rules to government regulation to TikTok competition – but ultimately it is the cyclical nature of their business which makes them most vulnerable.
On the other hand, there are the likes of Microsoft and Apple which are, arguably, less cyclical and better able to weather economic storms. By providing essential business infrastructure, Microsoft has a much less volatile earnings profile. While not immune, they can better navigate challenging economic conditions due to the essential nature of their products. It can also be argued that Apple has shifted their business model and is generating stickier and more recurring revenue streams. With mobile devices no longer a luxury but rather a necessity, Apple has become the preferred ecosystem, capturing a significant portion of the ecosystem economics. Both the companies are more Staples than Discretionary.
This distinction is quite apparent in the multiples at which they are trading when compared with Alphabet and Meta. The latter group are both trading at significant discounts to Microsoft and Apple, which is due in part to the latter’s earnings stability and durability. Ultimately, the dispersions in “Technology Stock” valuations reflects in the lack of homogeneity among the various companies. They may be included in similar sectors, but the underlying economic drivers are vastly different.
Heuristics and classifications are helpful in making investment decisions but can be detrimental when applied incorrectly. When analysing these large cap companies, it is essential for investors to be able to identify the diverse underlying drivers, despite them all bearing the same label of “Big Tech”.