The ASX has been a consistent underperformer in recent years. Looking overseas to the US and the exact opposite has been true. The larger, FAANGM stocks (Facebook, Apple, Amazon, Netflix, Google aka Alphabet and Microsoft as they have been termed) have all continued to deliver stellar growth, driving the US indices higher in the process.
It just so happens that the larger businesses in Australia tend to be more mature older style operations, while in the US the contrary is the case.
Market concentration growing in the US
Looking to the US and these mega-cap technology names have played such a key part in driving markets higher that many investors have become increasingly concerned about their dominance in major indices like the S&P 500, where FAANGM stocks represent 25% of the index’s market capitalisation.
Although much has been made of this increasing market concentration, looking back at history and the dominance of such a few names appears less pronounced (see chart below – weight of largest 10 stocks top line, weight of largest 5 stocks middle line, weight of largest stock bottom line – 1927 to 2020).
Shifting Sands: Old World v New Age
In years gone by, equity indices were largely driven by old economy sectors. Macquarie outlines that during the period from 2001 to 2010, 95% of average yearly returns were delivered by what we would describe as ‘old economy’ or ‘old world’ businesses and sectors.
Looking at the last decade, however, the picture is somewhat different. Old economy sectors have accounted for less than 40% of index returns, whereas new economy sectors, such as software and healthcare, have been responsible for over 60%.
According to statistics provided by the Macquarie research team, the average index weight of ‘new economy’ from 2001 to 2010 was less than ~5% in China and ~37% in the US. Today, the figures are closer to ~50% in China and ~60% in the US.
One particular OECD study highlighted that the productivity of the top 5% of firms in any industry is now growing at 4-5 times faster than the productivity achieved by some of the laggards.
These days, the share price of the top 1% continued to steadily climb over the last two decades, with around 40%-45% of today’s EBITDA delivered by the top 1% of profit generators. In essence, an increasing proportion of the ‘winnings’ are going to a decreasing proportion of companies within industries.
Growth at any price?
In a world of disinflation, as well as a low, volatile, and unpredictable growth outlook, quality businesses able to generate sustainable growth have become increasingly more valuable. Nowhere is this theme more obvious than on the ASX, with the WAAAX (Wisetech, Altium, Afterpay, Appen and Xero) stocks, whose performance over the last five years has dwarfed even that of the FAANGMs (Facebook, Apple, Amazon, Netflix and Google and Microsoft) as growth starved local investors herd into a limited number of high growth names.
Just because a company is large and well known today, doesn’t necessarily mean it’ll remain that way into the future. Equity investors need to overcome familiarity bias and focus on the future, what is to come rather than what has happened in the past.
There is no doubt Afterpay (APT) and any companies of the like are valued at multiples that are hard to justify based on traditional valuation metrics. In many aspects, current prices have extrapolated recent success and embedded world domination price. As such, we caution investors about chasing the next ‘Afterpay’ and blindly following momentum, as there are never any shortcuts when investing in equity markets.
Nothing can or ever will substitute for time spent analysing and deeply understanding a business. Investors need to be careful not to get caught up in momentum at the expense of earnings, and ensure they continue to look for growth at a reasonable price.
3 technology stocks that might do an ‘Afterpay’
As a word of caution, we would not necessarily go out and buy each of these three names today. Nevertheless, it is our view that should the good news flow continue, and management keep the business on the right path, there is a high chance of meaningful success.
The three technology stocks that might do an ‘Afterpay’, perhaps not necessarily in terms of percentage returns but in respect to taking advantage of a large and growing addressable market are as follows.
Stock 1: Megaport (ASX: MP1)
Megaport is a provider of elasticity connectivity and network services, operating under a Network as a Service (NaaS) business model. The company prides itself on offering the world’s first elastic SDN-based interconnection fabric, which accelerates connection between customers and data centres.
Such technology can be analogised to that of the role of a roundabout. A roundabout allows drivers to efficiently change directions and quickly access different roads instead of driving to the end of one road, then turning to get to the other. Likewise, Megaport allows businesses to swiftly access multiple cloud databases – the likes of Amazon Web Services, Google Cloud Platform, IBM Cloud, Oracle Cloud, Salesforce and SAP – through a single platform. Except, unlike a roundabout, Megaport enables access to cloud databases regardless of the business’ geographical location.
This is extremely important in an environment where many multinational corporations have several business operations across several countries and use several cloud databases, depending on the location and business. Megaport effectively streamlines the communication by allowing data stored in different cloud servers and countries to be accessed universally on a single platform.
Megaport provides a unique payment system to cloud and data centres on a pay-as-you-go basis in terms of capacity, speed, pricing and contract length, rather than licencing or subscription fees. The intrinsic value of Megaport is strengthened by its wealth of some 1,842 customers, which include Adobe, BHP, Blizzard Entertainment, FedEx, ING, Major League Baseball, Tesla and Zoom.
Management has confirmed COVID impacts have not been significant, and we actually see COVID as being more of a catalyst to speed up the shift towards Megaport’s services, as the cloud computing and data centre demand continues to grow.
Stock 2: PointsBet (ASX: PBH)
Pointsbet is a cloud-based sports and racing bookmaker. The company does have operations in Australia, but with the market very much mature and saturated, the true potential for Pointsbet and the part of the business we see as having the biggest opportunity is the large and rapidly growing US market.
At first glance, Pointsbet appears like any other sports betting service and provides the typical offerings as any other standard platform. However, it differentiates itself with its patented ‘pointsbetting markets’, which add a new level of strategy and excitement to betting.
Basically, the game-changing concept is to pick an outcome with an amount to wager per point – the more correct you are, the larger the payout. For instance, if a bet was to win by 1 point above the line (the score offered by Pointsbet), customers would receive $1. If it was to win by 20 points, customers would win $20.
With the amount of sports betting in Australia, it is hard to imagine a sports-centric country like the US had a nationwide ban on sports betting right up until 2018. At that time, a supreme court ruling passed the ability to legalise sports betting over to individual states. Logically, the revenues involved make this a very enticing prospect for states and for this reason, we have seen and expect to continue seeing an explosion in the number of states legalising.
Pointsbet is positioning themselves as one of the first movers in the US. With a unique offering, quality technology and large marketing budget, they are continuing their aggressive growth strategy to lock in an early piece of a market with unbelievable growth potential as additional states begin to open for business. In a matter of months, Pointsbet has seen their US market opportunity expand as each new state comes to legalise sports betting. With only a minority of US states accessible so far, the runway for growth is still extremely large. And as the market grows, even a small market share for Pointsbet will prove lucrative.
Stock 3: PushPay (ASX: PPH)
Pushpay Holdings Limited is a cloud-based online payment solution that provides a donor management system, including donor tools, finance tools and custom community app, to religious organisations, non-profit organisations and education providers in the US, Canada, Australia and New Zealand.
Founded in 2011, Pushpay operates under a SaaS (Software as a Service) model, with a heavy emphasis on churches. As of 31 March 2020, Pushpay maintains a customer base of 10,896 churches and an annual revenue retention rate of 100%. While Pushpay is listed on both the Australian Securities Exchange (ASX) and New Zealand Stock Exchange (NSX), 98% of its customers are in North America (US and Canada).
Pushpay’s acquisition of Church Community Builder, a US-based leading provider of church management system (Chms), in December 2019 proved to be “God’s gift”. The acquisition complemented Pushpay’s custom community app and donation solution, such that online churches could manage administrative affairs and ensure church announcements, sermon streaming, and mobile giving were maintained throughout the quarantine period. We argue Pushpay’s integrated system for churches poses as a powerful competitive advantage that differentiates them from other payment process services like PayPal and Stripe.
We are also very encouraged by Pushpay’s total processing volume growth rate, as a key component of their revenue is the processing fee of 1.8%. In FY20, total processing volume increased by 39%, amounting to US$5 billion, which is expected to grow more as Pushpay states most churches see a 76% growth in recurring givers in their first 6 months without losing current givers.
With social distancing restrictions expected to continue, Medallion is encouraged by Pushpay’s prospects as revenues and gross operating margins jump, all while total operating expenses improve.
At Medallion, there is a strong emphasis on the founder and management team’s involvement, as we believe it increases the likelihood of management’s interests aligning with shareholder interests. Hence, we find co-founder Chris Heaslip and Directors’ equity stake amounting to 49.7% encouraging, as it suggests there is a vested interest for management to grow the company.
We view it as a great opportunity to take a position in a business that is rapidly growing their customer base, revenue, and margins, both organically and through targeted acquisitions. While Pushpay’s customers are predominantly North American, it is important to consider the prospects of global expansion, given the world’s Christian population is 2.3 billion.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.