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WAAAX on – WAAAX off – The Rise of Australian Tech stocks.

Luke Sheather
Luke Sheather
Posted 06.10.2020 in Investment Planning
The rise of Australia’s technology market has been a revelation in recent years. Just five years ago our Information Technology (IT) sector was a drop in the ocean, comprising only 0.8% of the ASX 300. Today IT sector market capitalisation has increased five-fold to over 4%.

It’s still a small number compared to Australia’s famed Financials (25%) and Materials (20%) sectors. But perhaps we are witnessing the beginning of a structural shift in the Australian business landscape.

Conversely, the trend may only be temporary given the extremely favourable market conditions for growth-oriented technology companies in recent times. Cheap borrowing costs, a COVID induced tech-frenzy and relentless commercial demand for increased productivity and innovation have all been strong tailwinds.

Australia’s “WAAAX stocks” have been the darlings of the Aussie tech movement. Wisetech (Logistics Software), Afterpay (Buy Now, Pay Later), Altium (Electronic Design Software), Appen (Artificial Intelligence) and Xero (Cloud Accounting) are five businesses that have certainly been beneficiaries of this supportive environment. The table below shows just how well these companies have done over the last three years.

Total Return Performance since common inception (1/7/17 – 30/9/20)

Source: Bloomberg

No one can dispute that recent performance has been outstanding. However, there are varying views on whether these companies are still worth investing in today, given the very lofty valuations and multiples they are now trading at.

A conventional approach to valuing share prices would have us consider a company’s current price relative to its expected future earnings, in determining whether the share price is over or undervalued. The chart below compares the average Price / Expected Earnings (PE) ratio for Australia’s IT sector1, against the same ratio for the broader ASX 200 index.

 

 

 

 

 

 

 

 

 

 

 

Source: Bloomberg

The average IT company is current trading at a PE multiple of 79, while the average company on the ASX 200 is currently trading at a multiple of 20.5. What this effectively tells us is that investors are currently willing to buy shares in tech companies at almost four times the price that they would otherwise pay for another company, with same level of expected earnings. Based on this chart alone, you certainly couldn’t fault an investor drawing the conclusion that tech stocks may be a touch overpriced.

However, Afterpay’s departing CFO, Luke Bortoli, has a different take. In an interview with the Australian Financial Review, Bortoli suggests that such business valuations may be justified. Alluding to Afterpay’s Total Addressable Market (T.A.M.) of $5 trillion in the US and the business’s phenomenal growth trajectory, Bortoli declared “that sort of growth naturally commands a high multiple”. At the time of writing Afterpay’s Price to Earnings multiple was north of 1000.

Total Addressable Market refers to a tech company’s ‘blue sky’ opportunity, and It goes something like, “if we take over the world, we’ll be worth gazillions.” While T.A.M. may be approximated, the real level of future market share is much harder to ascertain. Unless you have a crystal ball up your sleeve, the future competitive and regulatory landscape can be very difficult to foresee. Particularly for relatively young industries, like the Buy Now, Pay Later industry.

What we do know is that there is no single metric that can identify whether a company is over or undervalued, without consideration of other factors. Unfortunately, there’s no “one measure fits all” solution.

There’s no doubt high growth tech companies need to be part of a properly diversified portfolio, however backing the trend and really weighing into these new trends has its risks. The FOMO risk, or fear of missing out, has seen many investors pile into these stocks and take overweight portfolio positions. Only time will tell us how this works out.

At Capital Partners we work to take FOMO out of the portfolio equation by taking a disciplined, systematic approach to investing that takes positions in companies which have displayed high profitability, like a number of these WAAAX stocks. However, more distinctively, our process also considers the relative price of potential investments, ensuring that value is captured and that we’re not paying too high a price for past performance.

http://www.afr.com/technology/afterpay-cfo-s-sky-high-value-defence-20200925-p55zal?btis

1 S&P/ASX 200 Information Technology Sector

Luke Sheather
Luke Sheather
Luke Sheather
As Capital Partners Investment Specialist, Luke does far more than simply identifying and recommending investments, Luke sees it as his role to help clients contemplate and answer life’s big questions.