A traditional approach to value investing can rely on owning low-multiple stocks expecting mean reversion to generate long-term alpha.
In our view, this is a flawed approach because you risk getting stuck with value traps – or businesses at risk of being disrupted in a world that’s changing so quickly.
When taking a pragmatic approach to value, value can be found right across the market spectrum – even in big tech – by identifying resilient businesses that are cheap relative to their growth profile and cheap relative to their peers.
Big value in big tech
When we look at two of the biggest tech names in the world, Facebook and Microsoft, we find two inexpensive businesses offering pragmatic value (both are top 5 holdings in Antipodes global portfolios).
For Microsoft, it’s growing earnings at 15%+ p.a. with a high degree of confidence around that earnings growth.
Despite this, it’s current valued at 27x calendar 2023 earnings – a 40% discount to its direct peer group. It’s cheap relative to its growth profile, and it’s cheap relative to smaller, single feature peers.
It’s a stock we’ve held since inception, but we think Microsoft remains a compelling investment.
It has a huge R&D budget for product development – around $20b p.a – which dwarfs that of start-ups. When it comes to product innovation, there are seemingly no boundaries.
And it maintains an unrivalled ability to bundle and cross sell those products across a very large customer base.
An Office 365 subscriber pays, on average, just $15/month. If you tried replicating your Office bundle by downloading a bunch of applications such as Zoom, Slack and others, it would easily cost in excess of $100/month. This makes Microsoft hard to disrupt and this pricing umbrella gives the company scope to lift its prices. We can see the average subscription price doubling over the next decade.
Microsoft’s Cloud Infrastructure business, Azure, also offers a significant embedded growth opportunity. Growth in cloud is shifting away from start-ups to being driven by the traditional enterprise – the customer group Microsoft has the lock over.
Azure is growing at 45% p.a. – which is pretty amazing for a business that’s 30b in revenue – and it’s growing faster than Amazon Web Services’ 35% p.a.
Similarly, Facebook is a company compounding its earnings at 20% p.a. and we’re only paying 20x for those earnings.
The Facebook group has 3.5b monthly active users. Four of the top seven most downloaded apps globally over the last year were Instagram, Messenger, What’sApp and Facebook – which is remarkable given how dynamic social media is. It’s no wonder Facebook continues to take share of advertising dollars. And remember the company is still only monetising core Facebook and Instagram.
The power of Facebook and Instagram as advertising platforms is they are equally valuable to the biggest brands and the smallest, unique brands. This is important given the shift in online consumption – which is less about buying what we know to buying what we discover, and it’s influenced by social media.
Facebook and Instagram are in the box seat.
Overlooked tech giants
While the quality of Facebook and Microsoft isn’t lost on the market, the attractiveness of other big tech stocks can occasionally fly under the radar.
A software giant that we think is currently being overlooked by the market is Oracle Corporation.
It’s a US multinational platform company that’s taking share in cloud ERP – and the market is just beginning to notice.
Transitioning from an on-premise ERP product to a subscription-based service not only doubles the value of an Oracle customer over the life of the contract it also significantly increases Oracle’s potential customer base, as it’s much more affordable to smaller enterprises. Further, Oracle’s on-premise database business continues to grow and over time Oracle will convert customers to its cloud solution.
With Cloud ERP now growing more than 40% yoy, we’re reaching an inflection point. We see Oracle’s earnings growing at high single digits and it’s valued at just 19x earnings, plus it’ buying back stock.
Disruption across industry sectors
Microsoft, Facebook and Oracle are great examples of pragmatic value; market leaders that are cheap relative to their growth profile and are not under the threat of disruption.
But disruption is not limited to the tech sector. It can be found through the market spectrum.
Retail is a great example, consider Amazon and Tesco.
Prior to COVID, e-commerce was around 15% of retail sales in the US and it quickly shot up to 22% thanks to lockdown.
Amazon has been the winner, with almost 40% of the US e-commerce market. This equates to almost 10% of total US retail sales – Amazon is almost the same size of America’s largest retailer Walmart (14% share) but with no physical stores.
Amazon’s dominance in e-commerce primarily comes down to the investments it’s made in logistics and improving price and breadth of choice for customers.
With a low threshold for free delivery and same day/one day delivery across almost 20% of the US population (and growing), Amazon sets the bar very high for online peers. We expect the company can continue to take share.
On top of this unassailable lead in e-commerce, the Cloud infrastructure business – Amazon Web Services – is still growing at 30%+ p.a. Here we have the largest player in two mega trends with earnings growing more than 30% p.a and valued at 23x core 2023 PE.
At the other end of the new retail spectrum there’s UK retailer, Tesco.
While better known for its physical supermarkets, Tesco is not new to online – Tesco.com was launched in 2000.
Tesco’s 30% share of online grocery is greater than its in-store share – so Tesco’s a market share winner as consumers transition online. It has unrivalled coverage of almost the entire UK and Ireland, and the UK is much more densely populated than the US, which is key to running a profitable online business.
Much like Walmart, Tesco is leaning on existing store assets – investing in fulfillment centres attached to large stores and using existing stores to fulfill online orders.
At 11x earnings Tesco is not priced for success in an digital world. It’s valued at less than half the multiple of other global leaders like Walmart and Woolworths.
Amazon – a new-world tech giant – and Tesco – a traditional retailer misunderstood by the market – are both winners from digital change and represent value for their growth profile.
Both have a place in a pragmatic value portfolio.
Good Value podcast
In the latest episode of the Good Value podcast, I discuss Antipodes’ approach to finding value in big tech and other parts of the market, with James Rodda, Portfolio Manager of Consumer and Domestic Services, Developed Markets.
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