Each decade or two a small group of powerful mega companies emerge to dominate markets. They seem as impervious to attack as once did the giant dinosaurs that stomped through earth’s swamps millions of years ago. But eventually something brings them down. They will not all become extinct, but they may become barely recognisable.
A lot of factors can cause a company to topple. Nokia had more than half of the market for mobile phones when Apple introduced the first iPhone in 2007. It failed to adapt and within seven years had lost 90% of its market value. Its mobile and devices division was sold to Microsoft.
Go back to the 1980s and 1990s and one of the biggest companies in the world was General Electric. Under the leadership of Jack Welch, its market value grew from $14bn to more than $410bn and it expanded from manufacturing light bulbs, television and white goods into other areas, including financial services, plastics, nuclear power plants and even television.
But after Welch’s retirement the business quickly imploded. In the words of Bill Gates: “It’s a textbook case of mismanagement of an overly complex business.” Today GE is worth around $92bn.
Often the fundamental flaws of a company only become obvious with the benefit of time. As investors, we must guard against recency bias. It is human instinct to want to stick with companies that have been a source of rich returns for us.
When troubles set in for a company and problems become much more apparent, investors can tune out. And that is reflected in valuation multiples that tumble, critically undermining the share price for years to come.
Over the past 20 years the strongest, most disruptive companies in the world have been the high-quality growth companies. One group in particular became famous for the acronym, FAANGs – Facebook, Apple, Amazon, Netflix and Google. Strictly speaking we should now call them MAANA as Facebook is now Meta and Google Alphabet.
Last year investors in these and other high-growth giants saw their shares take a hit. Rising interest rates caused markets to question the companies’ valuations, which had become stretched. January saw a bounce. But will this recovery be enduring? Bloomberg tells us that Meta, Apple, Amazon and Alphabet in aggregate missed consensus estimates by 8% in the fourth quarter of 2022.
Can the growth companies that have dominated many portfolios for a decade prosper in a world of high interest rates and an economic slowdown? Perhaps, but investors whose instincts are screaming to stick or pile back in to their once-high-growth shares may want to consider the following points.
Firstly, as big index constituents, the shares have been supported by some powerful technical factors: a demand for US dollar-denominated assets and the popularity of index funds. These trends may already have started to abate and the (arguably significantly) overvalued US dollar may have started a longer-range devaluation move.
As China reopens and inflation plateaus and falls, the global economy may end up in better shape over the coming year than risk-averse investors had expected. Might we start to see investors increasingly diversifying their exposure?
Secondly, it is not uncommon for markets to surprise with counter-trend rallies that can be false dawns. Experienced investors often fade in these rallies – in other words, they use the opportunity to take profits and move on.
Thirdly, how well do you believe management can cope with the prevailing economic conditions given their scale? In January Alphabet announced it was cutting around 12,000 jobs from divisions across Google. Amazon and Microsoft are losing 28,000 staff between them; Meta (Facebook) is dropping 11,000.
These businesses have been run for years on the assumption of high levels of growth and accommodative funding conditions. Many of them added to their headcounts in the wake of the pandemic on the back of a surge in demand and the acceleration of the digitisation of the economy. They arguably over-recruited; can they manage downsizing?
And have they overdiversified, too? Alphabet has interests in life sciences – it is working on glucose-sensing contact lenses that might monitor the onset and progression of eye disease, for example. It owns Fitbit, YouTube and energy solutions company Nest. We do not think of high-growth tech companies as conglomerates – a phrase more associated with ‘old economy’ businesses – but doesn’t that feel like an apt descriptor for Alphabet today?
We cannot deny that these companies are working hard to stay relevant and avoid Nokia’s fate. Microsoft has joined Meta in attempting to colonise the metaverse. Its $75bn bid for video games developer Activision is in part to provide the building blocks for this virtual reality world generated by computers. Meanwhile it is competing with Google in AI chatbot technologies.
Looking ahead
I am not saying that these high-growth giants have suddenly become bad companies. They appear in several of our funds. But where they do feature, they are part of a balanced portfolio that is being closely monitored and actively managed.
I am saying that investors should not dismiss how hard it is to run these large, diffuse, complex businesses with incumbent monopoly positions and returns that attract the attention of regulators and competitors alike. They should not ignore the technological challenges of staying ahead – identifying and backing the right new technologies successfully is hard. Nor should they underestimate the impact of a new economic era – quantitative tightening, positive interest rates and rising prices.
History suggests at that at potential turning points like this, investors should ensure more than ever that their portfolios are diversified and balanced. And they should have a base expectation that leaders of the last cycle are rarely, if ever, a source of outsized returns in the next.
Paras Anand is chief investment officer of Artemis Investment Management. The views expressed above should not be taken as investment advice.