Strategy Note / Global

Technology stocks cheaper in Taiwan-Korea vs US or China, let alone small EM-FM

  • Anyone who claims to know what Tech companies are worth in absolute terms (a 'target price') is an absolute charlatan
  • Forward multiples relative to history are sub-optimal but may be more useful than target prices for top-down investors
  • On this basis liquid EM Tech exposure is cheaper in Taiwan-Korea than US or China, with small EM-FM the most expensive
Technology stocks cheaper in Taiwan-Korea vs US or China, let alone small EM-FM

Always "I told you so" in Tech

The NYSE FANG+ index is down 10% in September to date. This is the first monthly decline in FANG+ since February 2020 (when there was also a 10% drop but from a much lower level, with FANG+ increasing 90% in the five months spanning April to August).

No doubt the investment industry is littered with folk saying "I told you so"; it is just that some of them do not confess to saying these Tech stocks were too expensive in April and the rest do not confess to saying they were too cheap in August.

Anyone who claims to know (or even sensibly estimate) the absolute value of Tech stocks (ie anyone who truly believes there is merit in a Tech company target price) is an absolute charlatan.

Not only is picking a winning start-up very hard, picking a Tech company with near terminal competitive advantage is even harder. And then valuing that business model with absolute precision is so hard it is impossible.

I speak from personal experience — I used to cover Nokia, when most of the mobile connected world carried one of their models, Apple was famous for its IIe, Mac and iPod, Samsung phones were regarded as imitations with tinny-sounding ringtones, and Xiaomi was better known as the start of the iconic line in the hit movie Jerry Maguire. If they are still doing the same jobs, I wonder if my contemporaries on AOL, Cisco, Intel, Lucent, Nortel, Yahoo! et al reminisce with the same guilt (thankfully, no one had to cover MySpace).

Top-down relative valuation in global Tech

Everyone can agree that growth in Tech is superior to that available in other sectors. New forms of behaviour (online socialising, gaming, commerce, entertainment, and, post Covid-19, online remote working) and new product cycles (eg 5G mobile, Artificial Intelligence, Internet of Things) are behind that growth.

And everyone can also agree that whether one likes Tech products, Tech company management or Tech company analysts and their target prices, the sector is so huge that it cannot be ignored.

Furthermore, there has to be some guide to valuation (unless valuation should take no part in the investment process across the entire portfolio in an era with so much passive, index-led, investment — this is a separate discussion).

In the very long term, most of the structural factors driving Tech growth (and the through-the-cycle risk-adjusted returns on capital) should drive hardware, software and applications, similarly. However, on a shorter time frames there are differences:

  • Hardware: more cyclicality given the capex-intensive nature of suppliers and the intermittent replacement cycles of consumers (as long as hardware manufacturers' designs remain compelling and competitive);

  • Software: less cyclicality but slower growth once a software platform establishes its foothold (a lower risk recurring revenue model);

  • Applications: closer to a winner-takes-all business model because of low switching costs (ie more subject to the whims of adoption and competition but enjoying unrivalled operating leverage).

Furthermore, because of the global nature of the addressable market, these structural factors should apply similarly to well-established Tech companies across the US, China, and Taiwan-Korea (assuming the US-China Tech Cold War, or "Splinternet", does not completely derail the global Tech companies, as they are currently constituted).

In other words, Tech companies across the value chain (hardware, software, applications) and geographic (developed or emerging markets) spectrum should be considered with equal enthusiasm (or disdain).

In addition to bottom-up, company-specific analysis of product cycles, supply chain indicators, and competitive advantage, and relative valuation among comparables in each sub-sector of Tech (eg semiconductors or e-commerce) there is, perhaps, also a case for comparing top-down valuation globally.

If there is little confidence on absolute valuation (target prices) and there is also little confidence on what the average multiple should be (in absolute terms) for a sub-sector in Tech, then it may make more sense to consider valuation multiples relative to history, even if that history is not very long.

For example, consider three indices:

  1. NYSE FANG+ (representing mainly US Tech Mega Cap, with roughly 10% weights for ten stocks in total like Apple, Amazon, Google, Facebook, Tesla, Netflix, although two of the index stocks, or c20%, are China Tech application stocks, Alibaba and Baidu);

  2. MSCI China Consumer Discretionary (representing mainly China Tech Apps, with c75% of this index made up of Alibaba, Meituan Dianping and JD.Com); and

  3. MSCI EM Information Technology (representing mainly Taiwan-Korea Tech Hardware, with c65% of the index is made up of TSMC, Hon Hai Precision, and Mediatek in Taiwan, and Samsung Electronics and Hynix in Korea, 14% from smaller cap Tech hardware players in Taiwan-Korea, 13% from China Tech hardware companies like Xiaomi, and 8% from Indian IT offshore software services companies like Infosys and Tata).

Current forward PE and forward EV/EBITDA relative to the median value seen since the start of 2019 (from when consensus estimate data is available across the three indices) suggests that within large Tech globally, that valuations relative to history are cheapest in Taiwan-Korea Tech Hardware, followed by US Tech Mega Cap, and lastly, in China Tech Apps.

The two largest Tech stocks in small EM-FM, Mercadolibre and Yandex (Sea does not have positive earnings or EBITDA), look the most expensive on this basis and this gives an indication of how much of a premium investors in small EM-FM are having to pay for such scarce exposure to liquidly traded Tech.

Related reading

Disruptive Technology and low FX controls risk in small EM via overseas listings (April 2020)

Chasing technology's tail: EM equity strategy overview (June 2020)

'Splinternet' problems for EM equity investors (August 2020)

US weaponises all Tech regulation in China friction, EM Tech in the cross hairs (August 2020)


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