In my prior role at RBC Dominion Securities, I used to share the below slide at events where I was brought in to speak with clients such as our loyal weekly readers.
I used it to make a case that many of the world’s best, and most tech-forward, existed in the U.S. There is the added mind-blowing observation that the market capitalization (that is all the shares outstanding for a company multiplied by the current stock price) of a mere four companies was almost 1.5x as large as the ENTIRE Canadian stock market.
Let’s take a look at what this slide would look like today.
A mere four companies are nearly 3x the size of the entire Canadian Market. Add in Microsoft and you have five companies with over $5 trillion of market cap that make up nearly 16% of the S&P 500.
These numbers are so big you can have a lot of fun with them. For instance, on July 20th Amazon added the entire market cap of Royal Bank + $18B in a single trading day.
The resilience of these tech companies has been met with an increasing discussion lately about how the U.S. market rally we have experienced has been driven by a small group of winners. Year-to-date, the S&P 500 is up about 2%. Facebook, Microsoft, Amazon, Google (now called Alphabet), and Apple are up over 35% year-to-date. The other 495 of the largest businesses in the United States are down a collective 5% (see chart below).
A word on benchmark performance calculations
On the plus side, we can use this as an opportunity to let our readers know that we happen to own Apple, Amazon, Facebook, Microsoft, and Alphabet in our client portfolios for those following our U.S. stock process. Apple has been a more recent addition, taking advantage of the price weakness in March. The other four companies have been long-standing positions in our portfolio for years.
It is important to note that the S&P 500 is a stock index that is market cap based. This means that the larger a company is, the more weight it is given in the calculation of the index’s performance. As the Apple, Amazon, Microsoft, et al continue to grow in size, their individual performance has had a much greater effect on the overall index performance calculation.
The fact that a handful of businesses have had great YTD success does not imply that nothing else has worked. Many of the companies we own in our U.S. model have robust YTD gains – Thermo Fisher is up over 25%, Danaher is up over 30%, Crown Castle is up over 20%, and Costco is up over 11%, to name a few.
What this math really highlights is one of the flaws in index calculation, which is one of the reasons we aim to avoid comparing our client portfolios directly to index benchmarks. Our portfolios do not resemble the benchmark, they are less risky than the benchmark as we lean towards high-quality companies, and as such it makes for a rather bad measure of comparison.
Why has big tech been so resilient in the face of COVID-19?
It is important to understand that these businesses were already viewed by most investors as secular growth companies. That is to say, their growth is a function of changing trends in the world and not a function of the normal business cycle. Below, we briefly highlight the trends each is playing on.
Alphabet – 90% + market share of internet search in Europe and North America paired with the shift of multi-billion dollar ad budgets from TV/print to digital mediums
Apple – Ubiquity of smartphones and digitization of content
Amazon – Shift towards e-commerce and enterprise cloud computing
Facebook – Shift of multi-billion dollar ad budgets from TV/print to digital mediums
Microsoft – Shift of enterprise spending toward cloud computing.
If you think about the world post COVID-19, I would argue that some of these secular trends i.e. Amazon and the shift of retail sales from brick and mortar locations to online, have accelerated. The trend was already there but COVID-19 was like a boost of rocket fuel and likely will have accelerated that shift for many (See the below chart from McKinsey Consulting)
A second argument is that the world remains highly uncertain given COVID-19, which is hard to argue with. To many investors (us included), these tech companies are among the most reliable of businesses in an environment so uncertain. Consider this thought exercise: Who is more likely to cease payment in a given week?
1. The incremental Amazon Prime member who generally is affluent, with savings and disposable income?
Or
2. The incremental homeowner drawing electricity – already was in a difficult financial situation pre-crisis with very little savings.
It isn’t apples to apples, but the thought exercise is not crazy. It was believed in March that thousands of small and medium businesses would close forever as a result of this crisis. In March, there was a week where power demand in European countries was down between 14%-19% year-on-year. Over the same period, TV streaming was up 77%.
What all these businesses have in common is something we have discussed in our client conversations – recurring revenue. Amazon Web Service provides mission critical IT infrastructure for businesses of all size, as does Microsoft. These bills are being paid today. Apple possesses a number of recurring revenue services, including music and TV streaming, cloud storage, apple care, to name a few. The current crisis hasn’t slowed the uptake of these services.
Final thoughts
We have a lot of confidence that companies like Apple, Amazon, Microsoft, Alphabet and Facebook are long-term structural winners. While the long-term outlook for these business models is strong, it is not lost on us that these businesses are becoming crowded trades in the market today.
A time may come where these companies do sell off as investors rotate to other areas of the market. I believe, until it is evidentially clear that COVID-19 is a thing of the past (and there is no COVID-20), that these businesses will continue to find favour with investors.
Unless the long-term fundamental outlook for one of these businesses changes, we are not going to lose too much sleep with the ebbs and flows of the stock price of one of these companies day-to-day.