This article has been updated to reflect changes in market capitalization.
Five companies — Apple, Alphabet, Microsoft, Amazon and Facebook — account for more than $4 trillion of the S&P 500’s roughly $22 trillion market capitalization. Now the most highly valued companies in the world, their stratospheric rise and heavy weighting in the S&P have investors and market commentators asking a lot of questions.
As a Capital Group equity portfolio manager based in San Francisco, Mark Casey grapples with these questions daily. Here’s how he thinks about these companies and their potential for growth.
Q: How do you think about the rise of these giant companies in the tech sector?
A: First, I think referring to them as being part of the “tech sector” obscures more than it clarifies.
Of these companies, only Microsoft, via its Office and Server & Tools segments, and Amazon, via Amazon Web Services, generate significant portions of their revenue from corporate technology budgets. The rest of the revenue generated by these companies comes from budgets that have nothing to do with corporate technology spending.
Apple generates revenue primarily by selling replacement iPhones to consumers, and anyone who has misplaced his phone for a day will tell you that a phone now seems more like a consumer staple than a consumer discretionary or technology purchase.
Alphabet’s Google is a sort of digital yellow pages that generates revenue from advertisers paying to reach consumers when they’re researching things to buy. Facebook is like a TV channel that shows content from your friends and family and that generates revenue from advertisers who are guessing what might influence you when you’re seeking to be entertained or informed. Finally, most of Amazon’s revenue comes from its retail business.
All in all, these five companies have wildly divergent ways of generating revenue.
Q: How should we be classifying these companies?
A: I’m fine with classifying Microsoft as a company that’s part of the tech sector. I have no idea how to classify Amazon, which is No. 1 in e-commerce, No. 1 in cloud-computing service infrastructure and No. 2 in streaming video, behind Netflix and ahead of Hulu. Amazon is also a company making inroads into a diverse range of industries, including parcel delivery, online payments and offline grocery.
It’s similarly difficult to pigeonhole a company that, like Alphabet, is No. 1 in search, No. 1 in third-party advertising technology, No. 1 in user-generated video content (YouTube) and operates the world’s largest mobile operating system for smartphones (Android). The company is also the early leader in self-driving cars (Waymo), and investing in areas as diverse as life extension (Calico) and artificial intelligence (DeepMind).
One thing these five companies have in common is that they’ve proven themselves to be uncommonly good at developing and exploiting technologies to benefit their customers and themselves.
Q: Regardless of what you call these companies, are they fully valued here?
A: Possibly yes, possibly no, and possibly some of each. Only time will tell. That said, it’s easy to see how some of these stocks could turn out to be undervalued today.
Apple, for example, has a market cap of $796B, taxed net cash of around $110B, and thus an enterprise value of around $686B. Investors are expecting the company to earn $50B in the next 12 months, putting today’s enterprise value at less than 15 times that figure. Compared with how stocks in the U.S. have been valued during the past century, Apple’s current multiple strikes me as about average for what is plainly a well above average company.
Similarly, if we give Alphabet credit for its huge net cash position, the multiple of profit generated by the core Google business does not strike me as high relative to what’s been merited historically by companies with Google’s track record and growth prospects.
Q: How vulnerable are these companies to competition and new technological innovation?
A: Any or all five of these companies could fall victim to technology disruptions or competitive attack at any time. On the other hand, it’s not as though these businesses have never been battle tested. They have so far withstood quite a lot of competitive pressure — much of it from each other.
Google tried to kill the iPhone with Android, and though Android succeeded in getting 80% of the market by volume, the installed base of iPhone users continues to grow. Google tried to kill Microsoft Office with Google Apps, yet Microsoft Office’s installed base continues to grow. Both Microsoft and Google have tried to kill Amazon Web Services, but it remains No. 1 by a wide margin.
Facebook has tried to compete against Google in search, and Google has tried to compete against Facebook in social and messaging, but each company continues to hold its own.
Just as we should not ignore the risk that each of these companies will be disrupted by a new technology, we also shouldn’t ignore the possibility that one of these companies will disrupt some other part of the global economy.
Alphabet’s Waymo, for example, might possibly create a huge new business in self-driving car operating systems and transform the automotive business as we know it. Many of these five companies excel at the core machine learning technologies that could lead to similar outcomes in other industries.