Valuation discipline will be important in the coming years when investing in tech stocks, as high-multiple names are likely to see lower returns, according to Carmignac.
Despite a tough year for the Carmignac Patrimoine fund, the more racy holdings in its equity portfolio – like Amazon (AMZN), Wayfair (W) and Grubhub (GRUB) – contributed postively to returns in 2018.
“In my view with this backdrop of tightened liquidity, less tolerance for free cashflow negative stories with indebted balance sheets and high multiples, probably not going to work in the same way,” says David Older, head of equities at the Paris-based firm.
Indeed, the fund sold out of Amazon in early September at around $2,000 shortly after the firm reported stellar-looking second-quarter numbers.
That’s because, amongst the expanding margins in both its cloud infrastructure and advertising businesses, the e-commerce division was starting to show signs that its hitherto high growth trajectory was slowing.
Older says the market initially missed that, only really cottoning on when the trend was confirmed in third-quarter numbers. Accordingly, the share price, which was already slipping, fell a further 14% in the ensuing days.
The Patrimoine fund has reduced its exposure to those higher valuation names in favour of companies that are still growing at around 20%, but that have stronger balance sheets and multiples of around 20 times forward earnings. “Less risky, quality names,” as Older describes them.
These include online accommodation portal Booking.com (BKNG) as well as Google (GOOGL), which Older thinks has the potential for a big margin expansion the market is currently missing. Waymo, its autonomous driving platform, is undervalued, but the real excitement around the firm is Youtube.
“Our checks with advertisers show they are very positive on Youtube,” Older explains. “The ad formats on Youtube have really started to excite advertisers and a number of our consumer-facing positions like Delivery Hero have come to us and said Youtube is the channel they are focusing on for advertising. It’s where they’re seeing the greatest return on investment.”
Facebook Bull
But one stock Older is particularly bullish on is Facebook (FB), which Morningstar.co.uk revealed saw its position in the fund increased significantly back in May. Back then, Facebook was an extremely contrarian trade and Older still thinks there’s massive negativity around the stock today.
“People think nobody uses it anymore, or that it’s going to be dead; they’re going to get regulated. You can poke a lot at the story. But in my investment experience that’s generally the best time to be looking at something.”
But Older knows Facebook well – he invested at IPO – and recalls parallels with the negative sentiment towards the stock shortly after it went public in 2012. Mark Zuckerberg’s firm floated at $38 in May of that year but had lost more than half of its market value in the following 15 weeks on fears over the rise of the smartphone.
Until then, Facebook had invested in ad space on the basis that use on desktop computers was booming. Once consumers switched to using Facebook on their smartphones, demand for those right-rail ad spots shrunk rapidly.
In the end, Facebook solved the problem by creating ad space inside users’ newsfeeds, which ended up being hugely successful, Older remembers.
Today, there’s a similar story. “You’re seeing revenues coming down, expenses going up and people think the business model’s broken and Facebook’s imploding,” says Older.
As Facebook works to fix its newsfeed, which has landed it in hot water with regulators and politicians, investors are worrying where the ads will now be placed. They’re being moved into the stories format, Older explains. In the transition, ad revenue is being lost.
“Their revenue growth has been reset because they’re taking high-unit ad inventory away from the news feed and putting it over to stories. Advertisers don’t know about it yet.”
However, ads inside stories has been widely well-received on its ever-popular Instagram platform, suggesting that once advertisers are aware of this new inventory on Facebook they will flock back.
In fact, Older says he’s already spoken to advertisers who love the stories format on Instagram and are planning to copy that over to Facebook. Therefore, “we think this revenue trajectory that everyone thinks is flat is actually going to turn up”.
Meanwhile, changes to the newsfeed to make it more social, rather than news- and ad-heavy, could see engagement stabilise and, eventually, increase. “That could be an upside that no-one has baked in.”
Regulatory Fears Unfounded
Elsewhere, the scare stories about regulatory pressure, while real to a certain extent, has been exacerbated by a “biased” news agenda from media outlets fearful of the negative impact Facebook is having on their readership.
“The biggest threat to newspapers in the United States is Facebook: more than 50% of people in the US see Facebook as their primary source of news. So their negative articles are a little bit biased on that basis.”
A final potential “moon-shot to the upside” would be the opportunity to make Instagram “a real portal for e-commerce, based on apparel”. Older thinks there’s plenty to be gained by offering users to click through on products they like, buy it and for Facebook to take a percentage of the transaction.
Valuation-wise, meanwhile, is trading on just 17 times forecast 2020 GAAP, or rule-based, earnings – not “some bullshit internet-crazy adjusted earnings”. Older doesn’t think that low a valuation’s sustainable for a company that’s growing its top-line at 15-20%, even if margins fall by, say, a third.
“This is one of these great stories where the numbers are amenable, sentiment’s terrible, multiples are low,” concludes Older. The share price could even end the year $20 to $30 off a record high.
