The best thing about having the global mandate as a fund manager is you get to research and invest in the best companies in the world.
It’s worth remembering Australia is just 2.5% of the global equity world, and 20 large cap stocks make up around 70% of that 2.5%. However, Australian investors have a massive home bias with around 65% of their equity investments invested in Australian companies. Many SMSFs have 100% of their equity investments in Australian companies.
In my opinion that home bias asset allocation will continue to drive underperformance for Australian investors. The vast bulk of that underperformance will continue to be driven by Australian’s owning too many Australian banks and not having enough (or any) exposure to the world’s best technology growth stocks.
Below is a 1-year overlay chart of the tech heavy US NASDAQ100 Index (white) and the ASX200 Banks Index (green). I believe this will continue to diverge in favour of the NASDAQ.
The recent Q2 US earnings season confirmed the earnings and cash flow power of the “MAFIA”. The “MAFIA” is my acronym for Microsoft, Alphabet, Facebook, IBM and Amazon. They are extracting economic rent from all of us on a daily basis and their investment case is compelling.
The great US growth investor Peter Lynch believed the best investment ideas you see are with your own eyes in everyday life. I couldn’t agree more with that and at AIM we use the power of observation heavily in our investment process.
The “MAFIA” are and will remain the most dominant companies in the world. It is that simple and that is why I believe they are core positions in portfolios positioned for the future, not the past.
All the major “MAFIA” stocks beat consensus earnings forecasts in Q2 and saw both their CY16 and CY17 earnings estimates lift. On price to growth ratios and EV/EBITDA ratios, I believe the “MAFIA” will prove cheap and in multi-year earnings upgrade cycles.
I will explore the individual investment cases for the “MAFIA” in the weeks ahead but today I thought I’d start by focusing on Facebook (FB), a truly amazing company that is disrupting the advertising world.
Facebook is the largest social network, with over 1.5 billion monthly active users and 1 billion daily active users. Those in themselves are stunning numbers and must make FB the most recognised brand in the world.
The company owns Facebook, Instagram and What’s App. Speak to anyone younger than ourselves and their entire lives revolve around these three apps!
The younger generations are genuinely addicted to social media. There’s no turning back now and all measures of time spent on social media/mobile devices continues to increase. It’s a horrible, yet very accurate thing to write, but addiction is worth investing in. Addiction is a powerful earnings driver. Obviously I don’t invest in tobacco stocks (or anything that kills you), but tech addiction is a very powerful theme I am invested in.
The company generates revenue from advertising and revenue from payments, split at roughly 96% and 4% of total revenue. The company currently generates 49% of revenues in the USA and Canada and is expanding in international markets.
The investment thesis is that Facebook is the no.1 play globally on the structural growth in social media and mobile internet usage. It also has leverage to growing internet usage in emerging markets.
FB clearly has structural macro growth tailwinds, but at the stock specific level we expect FB to gain overall share in advertising markets driven by user growth, new product offerings and new ad formats. We forecast FB to grow by around +30%pa over the next three years. Try finding that growth in large cap Australia!!
A quick look at the Q2 numbers confirms all these trends. According to Bank of America Merrill Lynch research the Q2 number was a “clean beat” of consensus by +18%, which led to them upgrading their 2017 EPS by +10%. Again, try finding a large cap Australian stock seeing its estimates raised +10% for 2017!!
The earnings beat and upgrade was driven by growing users/engagement, strong advertiser demand, higher ad loads and Instagram. Margins at 58% also beat expectations.
The most important point of all was that daily users grew by +17%. The DAU/MAU (daily active users/monthly active users) ratio was stable at 66%, and time spent per user was +10%. In the conference call FB highlighted new video products (live videos, suggest videos), which we expect to be the next leg of user engagement growth. This is particularly so given Facebook’s app portfolio, which we continue to see the structural transition to mobile (from desktop) as a bigger tailwind than its internet peers. The FB network effect is enormous and consistently underestimated by analysts.
Interestingly, Mark Zuckerberg said this week that FB was remaking all its apps and services with video in mind, and he suggested in about five years’ time video may be the main way users want to communicate, socialise and be entertained. You wouldn’t bet against him.
You’d therefore think FB would be a “wildly expensive” stock for all its dominance and disruption. It is not: on all investment metrics, I believe it is cheap versus its future growth and free cash flows and that is why we own FB in the AIM Global High Conviction Fund. The free cash generation on its own is massively attractive.
Below are the 2017 forecasts for FB in USD.
I believe the numbers above confirm FB is a structural grower at a reasonable price. To be able to buy debt free structural growth at a PEG ratio of .71x or EV/EBITDA of 15.1x will prove cheap in my opinion on an 18 month investment view.
FB is a core member of the “MAFIA” and I expect all members of the MAFIA to increase their dominance in the months and years ahead. Any portfolio without a smattering of these great companies is reflective of the past, not the future.
We invest in the future and the future is bright for large cap US technology companies.
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 regards to your circumstances.
