In recent weeks stock markets have been booming, mainly thanks to the soaring values of the USA’s tech giants. Apple has become the first company in history to establish a stable valuation of over $2 trillion and the share price of electric car maker Tesla, considered more a tech company than car manufacturer by markets, has quadrupled in 2020.

Amazon, Microsoft and even Alphabet and Facebook despite the latter two seeing ad revenues hit by the Covid-19 pandemic, have also all added hundreds of billions to their valuations over the past few months. The likes of Netflix and Zoom have also benefited, pushing the S&P 500 and Nasdaq indices to new record highs, despite the carnage wrought on much of the global economy as a result of the coronavirus crisis.

We’re well and truly in the midst of a tech boom and many of those investing online have earned some serious returns in recent months. But with many analysts and market observers now worried we’re actually in a tech bubble, has the time to invest for those who haven’t yet already passed?

Would buying tech shares now run a major risk of investing at the top of the market with losses likely to follow when the bubble bursts in coming months? Or is there still some way to go for the valuations of big tech, meaning there is still an investment opportunity waiting to be grabbed by the laggards?

The majority of the 55% growth in the overall value of the S&P 500 since the market bottomed in March following the coronavirus sell-off has been generated by just six tech stocks – the FAANG five of Facebook, Amazon, Apple, Netflix and Google-parent Alphabet, plus Microsoft, the elder statesman of big tech. $3.9 trillion has been added to the market capitalisation of companies that form the FTSE 500 this year. $2.9 trillion of that, almost 75%, comes from just those 6 companies.

Is There Still More Upside For Investors Late To The Tech Party?

Those that believe big tech’s valuations have entered bubble territory point to huge volumes of cash that have been pumped into financial markets in recent years, and especially this year as central banks tried to control the fall-out of the Covid-19 pandemic. They believe that cheap money is what has driven valuations up so high, mirroring the economics of the dotcom boom of the late 1990s. And we all know how that ultimately ended.

The problem with so much money sloshing around the system is that when there is little restriction in supply, it tends to indiscriminately boost values, even of companies whose business models are perhaps not as robust and would struggle to survive under different conditions and without billions of funding, allowing them to grow market share while racking up heavy losses.

Tech investors have divided opinions on which of the giant tech stocks soaring in value this year are actually strong businesses that justify their market capitalisations. There is particular doubt over those which are not cash profitable, or barely so, such as Netflix and Tesla.

Quoted in The Times newspaper, Stephen Yiu of the Blue Whale Growth fund, two thirds of whose 25-company portfolio is made up of tech stocks, believes some of the tech companies to see their valuations soar this year are in bubble territory. But others aren’t and may still offer considerable potential upside for new investors.

The Tech Stocks New Investors Should Be Cautious Of

Mr Yiu is wary of Tesla and Netflix in particular and would not invest in either company at its current valuation. On Tesla he says:

“We would not be buyers of Tesla because it has a negative cashflow and operates in a very competitive market where it does not currently have a dominant market position or brand, and unless it does so it will not be able to make large amounts of money.”

Mr Yiu also has major doubts over the quality of Netflix as a business due to increasing competition making it, he believes, unlikely the video-content streaming platform will manage to generate strong and sustained returns on the huge amounts of capital invested in producing original content and buying the rights to third-party owned television series, documentaries and films.

Mr Yiu would also be wary of new investment in Apple at its now over $2 trillion valuation. His main concern with the iPhone maker is its exposure to escalating political tensions between the USA and China. He believes that geo-political threat is one than could negatively impact all of the big American tech companies, but Apple is particularly exposed due to a larger portion of its revenues coming from China.

Other analysts also see a disconnect between revenue growth and valuation growth for the tech giants, especially Apple. Russ Mould of online stockbroker AJ Bell comments:

“I get why tech companies are popular. They can generate organic growth when there is not a lot of it around, but I don’t get why Apple has added $1 trillion of market cap in four months when earnings aren’t growing that fast, the smartphone market is glutted and volumes are falling.”

“I don’t get Tesla at all when its market cap is more than that of Toyota, which has more than ten times the revenues. I don’t get Netflix’s inability to generate cash, which is a great example of the cashless prosperity we are seeing in many highly valued companies. They grab customers, but can’t turn them into cash.”

Mr Mould draws comparisons between the huge surge in the valuations of today’s tech giants and the ‘Nifty Fifty’ group of stocks in the 1960s, that included tech giants of the day including Kodak, Polaroid and Xerox. They were also viewed as a safe and profitable investment haven before their valuations collapsed during the 1973-74 stock market crash.g

Most Of The Tech Stocks Of 2020 Are Built On Stronger Foundations Than Those Of The DotCom Bubble

Tech valuations may look stretched, if not outlandish, as we head into the end of summer 2020, but many analysts also believe drawing comparisons with the dotcom boom is also not justified because today’s companies are built on stronger foundations. Many of the dotcom companies that reached valuations in the billions had little actual cashflow or customers.

Today, the more mature big tech companies, such as Apple, Amazon, Alphabet, Facebook and Microsoft, generate between 20% and 30% free cashflow margins and have hundreds of millions of paying customers. With the exception of Apple, it could be reasonably argued these companies are well entrenched market leaders with relative domination of their large markets and little realistic competition on the horizon to worry future growth prospects.

Will The Fourth Industrial Revolution See Big Tech Get Even Bigger?

We’re now in what is referred to as the ‘fourth industrial revolution’, which is seeing AI, cloud computing and other developing technologies boost productivity and open new markets for products and services newly technologically possible. The move towards a digital economy has accelerated the trend that was already firmly in place, driving revenue potential for companies in the space.

For Alphabet (Google Cloud Platform), Microsoft (Azure) and Amazon (AWS), their cloud computing businesses are growing quickly and now account for a significant portion of revenues. But with just around half of corporate data already transferred to cloud storage, there is still plenty more space for growth.

The biggest tech companies are also all capitalising on their momentum and financial might to move into and dominate new business verticals. Facebook, for example, is looking to challenge Amazon and Alphabet with its new Facebook Shops platform for small ecommerce businesses.

Microsoft would suddenly be a major player in the social media space if it pulls off its attempted acquisition of TikTok’s U.S. operations and Amazon is moving into groceries, pharmaceuticals and pretty much every other high value retail vertical that is still to mature as an online offer. The diversity of the sectors driving revenue for these companies is perfectly illustrated by Amazon’s growing e-sports business Twitch.

Some analysts even argue that it is wrong to view Tesla as a car manufacturer and judge its value against the same metrics as rivals such as Toyota or General Motors. Seeing Tesla as a technology company means assessing its value on its intellectual property such as battery technology and driverless vehicles technology it is developing. Not on how many cars it sells.

Anthony Ginsberg of the HAN-GINs Tech Mega Trend ETF comments on Tesla:

“The company is benefiting hugely from developments in battery technology and the direction of government environmental and urban planning policies. In particular the reduced and falling battery costs, which will drive higher profit margins at Tesla.”

Of all the big tech companies, there is most consensus around Microsoft and Amazon retaining the strongest future growth potential.

For investors still to gain exposure to the big technology stocks who believe current valuations now mean taking the plunge would be too risky, another option would be a tracker fund that follows the tech-centric Nasdaq index. All the biggest tech stocks are part of the index but so are smaller up-and-coming and established cash-positive tech stocks, that haven’t had the same runaway growth as the select group of the FAANGs + Microsoft. Across the index, the average valuation multiple is 38 times earnings, which is much lower than the risky multiples some individual stocks have reached, such as Netflix’s 80 times earnings.

Newer tech companies that may grow into big beasts over coming years will also come into the index, with poorer performing stocks dropping out, keeping the index at the cutting edge of tech growth. The companies in the index also cover a wide range of sectors and activities, from ecommerce to electric vehicles, AI, robotics, renewable energy and telecoms, diversifying investment risk.

But with big tech making up such a big part of the value of the Nasdaq, there is still plenty of exposure to those sky-high valuations. Shocks such as anti-trust action to clip the wings of the largest tech companies, or stricter regulations forcing them to pay more tax, could have a heavy impact on valuations as high as those we currently see.

On the flip side, big tech has demonstrated notable resilience and endurance. Revenue streams are also being increasingly diversified and, as the economist John Maynard Keynes wrote “markets can stay irrational longer than you can stay solvent”. The current tech boom could go on much longer than current naysayers believe, meaning there is still money on the table to be picked up by new investors. Or they could be buying in at the height of a bubble about to pop.

Big tech is a tough call for investors still on the sidelines.