History rhyming ...
They say that history does not repeat, but it often rhymes.
As observers of the run-up in the prices of technology stocks over the past year, your investment team has had an uncomfortable feeling of deja-vu.
Tech valuations: Deja-vu?
The graph below illustrates why: the share price performance of Australia’s top 10 technology companies over the past year and a half has been extraordinary. Since 2018, these companies (Xero, Wisetech, Afterpay, Altium, Appen, TechnologyOne, Netwealth, Bravura Solutions, Z1P and HUB24) have returned an average of 89%, versus the market (as represented by the All Ordinaries Accumulation Index) which has returned 7%.
Source: IRESS, First Samuel
This has been reflected in their valuations, which are now significantly higher than the broader Australian market:
Source: IRESS, First Samuel
Furthermore, from a historical perspective, valuations of Australian Technology companies (below; blue line) have now reached levels which mirror those seen during the “tech bubble” of the late 90’s in the US (green line):
Source: Schroders, Datastream, NASDAQ. NASDAQ top 5 companies: Microsoft, Qualcomm, Cisco, Oracle, Intel Corporation. Australian software/tech companies: WiseTech, Altium, Promedicus, Nearmap, Xero, Appen.
Prices therefore reflect extremely high expectations and significant downside risk if these expectations are not met.
A lesson from history:
To quote Warren Buffet: “Be fearful when others are greedy, and greedy when others are fearful”. The run-up of prices in technology stocks indicates that appetite for risk in this sector is high, and the scales have tipped towards greed.
Many readers are aware of how the tech bubble (and subsequent bust) played out in the late 90s. There has, of course, been considerable innovation and evolution in the technology sector since then (such as cloud computing, artificial intelligence, machine learning). What has not changed is human psychology and cognitive bias (leading to a propensity for valuations become exaggerated).
With companies priced to perfection, it takes very little to rattle investors' confidence and for prices to revert to more reasonable levels (resulting in losses for shareholders). What will result from this latest surge in prices remains to be seen, however, to us, these companies (at current prices) do not represent a favourable trade-off between risk and reward.
We are seeing pockets of exuberance in the market reminiscent of the tech bubble in the late 90s.
Valuations of technology companies have become stretched as investors are willing to pay increasingly higher prices for companies with a compelling growth story.
In our assessment (at current prices), these companies represent an unfavourable trade-off between risk and reward. In an environment where the appetite for risk is this sector is high, we prefer to take a lesson from history. Your investment team remains focused on investing in more reasonably priced companies with an ability to grow their dividends and earnings over the long term.
- Paul Grace