Technology stocks have driven much of the growth in world markets over the past decade and while valuations are looking stretched to say the least, the enormous disruption they are causing to traditional industries means few would bet against them strengthening their dominance over the long term.
Investors are not only holding these companies for growth – James Dow, manager of the Scottish American Investment Company (SAINTS), recently said technology could have an important role to play in income portfolios, backing the likes of US-based software business CH Robinson and digital publisher Wolters Kluwer.
“A fundamental tension exists in many companies between dividends and growth,” he explained. “Most obviously this occurs in business models which require large investments of capital to grow production.
“Happily not all companies require large capital investments to grow. By focusing on businesses which are naturally capital-light, investors increase the probability of enjoying both profit and dividend growth from their holdings.”
However, James Henderson (pictured) takes a different view. Industrials are the highest sector exposure in his Law Debenture trust and the second-largest in Lowland Investment Company, with the manager saying: “I like capital-intensive businesses”.
“What is their role? Well, that is what Warren Buffett would call ‘the moat’,” he said.
“People say Rolls Royce has got a problem with the Trent Engine at the moment, but one, it will sort this, and two, this is an incredibly complex and difficult thing to create and build. That gives you an advantage and a position that people don’t take on.
“How many millions of miles has the Trent Engine been flown in tests? Boeing’s Dreamliner is the long-haul plane you will fly in for the rest of your life; it may replace it in 40 years’ time, but my point is it’s a hell of a long cycle.”
Henderson believes this is what separates industrials from the tech stocks that are currently driving growth in markets. The manager said that not only are the valuations of tech stocks particularly demanding, but their lifecycles are shorter because they don’t require the same capital intensity to start up. He used the example of Vodafone to illustrate his point.
“When I started working, Vodafone didn’t even exist – it was a small subsidiary of Racal which was doing military communications,” he explained. “To give Racal its due, it grew Vodafone and then spun it out.
“In the 30 years I have worked, it has gone from nothing, to the fastest growth stock, to a mature company and in reality it has been a declining company for the past 10 years.”
Henderson contrasted this with a company such as Ford, which he said had half a century of explosive growth after its launch. Although it began to decline in the 1960s, he said this cycle has happened over a “huge extended period” and it is still an enormous company throwing off large amounts of cash.
“Vodafone’s time in the sun was literally three or four years when it was absolutely at the top before declining,” the manager added.
“My view is that while Amazon and Facebook are amazingly strong growth companies, their actual life-cycle could be shorter than we anticipate, so it could be quite dangerous putting huge valuations on them. Their time as top-dogs won't be forever.
“You have to be careful because the real winners of today won’t be the real winners of tomorrow.”
Henderson also has a significant exposure to the oil & gas sector. The manager said he is using this as a hedge because if the Middle East “exploded” and the oil price went to $150 a barrel, “all the tidy arguments about industrials would be well and truly messed up”.
Like industrials, the fate of oil & gas depends on global growth and with the expansion in the economy now one of the longest on record, numerous commentators have warned that a recession could be around the corner. However, Henderson is upbeat in this regard, saying firstly that the upswing has been muted and secondly traditional economic measures are failing to account for the technological developments that have helped to drive this growth.
“I was in Berlin a few weeks ago and, while a few new hotels have gone up, the actual capacity has shot up a lot more than it looks because Airbnb has suddenly opened up thousands of new rooms,” he continued.
“I was talking to younger people and they were renting rooms for what I used to spend 20 years ago and that’s because there has been this huge opening up of capacity out there that isn’t being fully caught in the numbers.
“Your iPhone is taping us now, you’ll be using it to talk later, you’ll be using it to take pictures – you individually had all those gadgets separately in the past. You haven’t got a cassette player, you haven’t got a camera, and that has hit those turnover numbers, but actually the capacity has grown enormously and that isn’t being recorded.”
The manager said this is important because recessions usually occur when there isn’t enough capacity in the economy. This leads to inflation and, if companies invest to increase capacity, any slowdown will see the additional fixed costs result in significant losses if they fail to generate extra sales.
“I don’t want to make any big macro calls, but the people who are saying the expansion has to end because it has been eight years aren’t actually analysing the amount of capacity that is there,” Henderson added.
“It is actually very cheap capacity and that is why inflation appears to be low at this stage – you’d expect it to be picking up stronger than it is, but it is not, because of the new capacity that has come into the system that is not being recorded fully.”
Data from FE Analytics shows Lowland Investment Company has made 213.7 per cent over the past decade compared with 138.93 per cent from its IT UK Equity Income sector and 119.29 per cent from the FTSE All Share.
Performance of trust vs sector and index over 10yrs
Source: FE Analytics
The trust has ongoing charges of 0.58 per cent and is yielding 3.33 per cent. It is 14 per cent geared.
It is on a discount of 5.91 per cent, compared with 6.36 per cent and 4.96 per cent from its one- and three-year averages.