BLOG: How do you spot the next Amazon?

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Written by: Darius McDermott
19/07/2018
While there’s no magic formula for finding the next big thing, companies shaking up the marketplace may be a good start.

The ‘FAANG’ acronym (Facebook, Amazon, Apple, Netflix and Google) has been bandied about by investors for some time now, and it’s hardly surprising.

Almost a quarter of the US stock market – the S&P 500 – comprises technology stocks, with these giants alone accounting for nearly 13%.

Technology isn’t just dominating in the US either. On the other side of the globe, China has its own acronym – BATs (Baidu, Alibaba and Tencent), which account for a third of the MSCI China Index.

Should investors buy, hold or fold on tech stocks?

The FAANGs have carried the US stock market in recent times: the S&P 500 has risen almost 80% over five years, but the technology sector is up more than 160%. And given their size, even if one of these stocks has a bad day, the index is likely to follow suit.

The performance of these stocks can indeed vary quite significantly. For instance, Amazon is currently performing well but Tencent, Alphabet and Facebook are weaker. Netflix has been strong up until it announced its Q2 results this week, when the stock fell by 14%. This meant the S&P 500 slipped 0.1% over 24 hours.

Not only this, some of the companies with the biggest market share can be very expensive relative to their indices. Amazon, for example, is currently nine times more expensive than the average stock in the US index.

There are plenty of tech opportunities outside of the acronyms, however. It’s just a case of finding them.

What are the alternatives?

I recently spoke to James Thomson, who runs the Rathbone Global Opportunities fund. He said while there is no magic formula for finding ‘the next big thing’, they have to be doing something very different and shaking up the pack.

“What we’re seeing is businesses having to upgrade their existing systems to tackle the challenges posed by the digital world and stay relevant for the next generation of customers,” he said.

“Around 75% of companies are spending money this way and recent meetings point to some of the strongest IT spending plans in years. Technology has become a vital tool for almost every business, and few chief executives would be bold enough to ignore it.”

In a bid to future-proof his portfolio, Thomson is maintaining a broad spread of tech stocks within the fund including internet, software, hardware, video gaming and semiconductors. All counted, they make up approximately 25% of the fund. Some of the lesser-known technology stocks in his portfolio include invisible braces manufacturer Align Technology, and video game manufacturers Electronic Arts and Activation Blizzard.

Tom Slater and James Anderson, who head up the Scottish Mortgage Investment Trust, also adopt a similar approach to stock selection. While they do hold the likes of Amazon and Alibaba in the portfolio, they also have slightly smaller names such as Illumina and Tesla in their list of top 10 holdings.

I asked Slater which ‘Amazons of the future’ are on his and Anderson’s radars at the moment, and he pointed out that Amazon itself is unique because it single-mindedly invests all of its profits in growth.

“Alibaba may be comparable in a sense but it is difficult to see the next one,” he said. “Both Amazon and Alibaba seem to buy up anything in their paths. Their respective chief execs Jeff Bezos and Jack Ma – and the culture they have instilled – are key to both companies’ success. The most obvious characteristic is that they are truly long-term in their vision (20 years plus) and ignore all short-term influences. They are also good at finding areas where they can dominate.”

What next for investors?

Ben Peters and Chris Elliott, who co-run the Evenlode Global Income fund, recently spent some time in Silicon Valley visiting their existing technology holdings and some start-up businesses hoping to become disruptors in their respective sectors.

“Even the consumer goods sector – the largest weighting in the portfolio – will be affected if consumers change their shopping habits as a result of artificial intelligence-enabled experiences. For example, imagine a future where we can order what we like, when we like, by shouting at our digital assistant – that’s Amazon’s vision for Alexa,” they said.

“In the next stage of the internet of things, artificial intelligence might observe our consumption behaviour, anticipate our need for a snack, and fill up the cupboard with our favourite brand before we know we want it. In this scenario, branding power becomes more important than ever.”

Elliott and Peters do not select companies based on their tech credentials alone – they say it is more important to find firms with forward-thinking management teams ready to take on whichever industry changes are suddenly thrown their way. That way, they’ll be able to harness new technology as and when it becomes available.

We agree with this theory. There is no doubt that the rise of technology is going to be one of the biggest market themes to keep an eye on over the long-term, but predicting ‘the next big thing’ is a fool’s game. For us, it’s about finding the managers which seek out innovative companies which are open to change.

Darius McDermott is managing director of FundCalibre

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