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Bet on Facebook, Alphabet proves cash is still king

February 2020
The Australian Financial Review
Robert Guy

Bet on Facebook, Alphabet proves cash is still king

February 2020

It's been a bruising week for the world's tech behemoths as Wall Street's savage sell-off left Alphabet and Amazon facing the ignominy of falling out of the trillion dollar club.


The slide in the market value of Alphabet and Amazon below $US1 trillion ($1.5 trillion) highlights the risk-off mood permeating global markets as the virality and globality of COVID-19 elevates concerns about a hit to global growth from lower demand and supply chain disruptions.


It was a week of reckoning for Wall Street.


Having pushed valuation multiples to their highest levels since the early 2000s and downplayed the gathering virus threat, the reality check of supply chain disruptions – as highlighted by Apple – and the impact on earnings was sharp and brutal.


Ned Bell, chief investment officer of global equities manager Bell Asset Management, says the slide reflects a realisation that there is a "pothole in corporate earnings that's still to come in the middle part of the year".



"There's earnings weakness to come against the backdrop of very expensive growth stocks and very inexpensive value stocks," he adds. "Momentum [and] growth as a factor has been so strong for so long and valuations have been out to one side."


Bell has been a long-time observer of the tech sector, having worked in funds management in San Francisco during the go-go years of the dot-com boom.

His time at the epicentre of global tech served him well as he first bought a stake in Apple in 2005 when it was trading at $4.50 a share, although he has sold down the fund's interest.


"We've trimmed too much," he says with a laugh. "We didn't have any premonition about the iPhone. The lights were flashing because it was generating a lot of free cash.


"The free cash flow yield was really good, it was generating a high return on capital."


There are two names that stand out for the fund manager among the US tech giants: Facebook and Alphabet.


"We look at businesses with very high levels of return on capital and trading on reasonable valuations. Alphabet and Facebook fit into those two buckets and there is still good secular growth coming out of those two names."


For Facebook, Bell sees plenty of growth – especially from its Instagram business.


"The secular growth has a fair way to play out in terms of Facebook and there's not that much economic sensitivity in terms of the earnings trajectory.


“It's trading on sub-25 times earnings and still has a huge amount of cash on the balance sheet."


It's that combination of growth, cash generation and appealing valuation that also sees Alphabet, home to search giant Google, get the tick of approval.


"Alphabet is similar. It doesn't trade on 50 times earnings – it's trading on a sub-20s multiple and growing its revenue at 15 per cent-plus. It has a very high return on capital."


Shares in Amazon and Microsoft have run hard but Bell says he has trouble with the valuations of the two companies.


He likes Amazon's AWS cloud business but is concerned about the capital intensity of its flagship retail business.


"The AWS business is fantastic and has a high return on capital.


"The valuation has been a bit of an issue for us. It's not a business we would rule out but the valuation at this point is a concern for us. "


Bell admits the fund sold Microsoft "way too early" and underestimated the growth of its Azure cloud business.


Car maker Tesler is a stock that divides opinions like no other.


There are evangelical supporters who believe it can dominate the electric vehicle market, while the cynics have their eyes firmly fixed on its lack of profitability.


For Bell, he's staying well away.


"I'd never go long but I'd never be silly enough to go short. They just don't make any money."


One part of the market that Bell sees plenty of growth in is global small-and mid-cap (SMID) stocks.


He notes that MSCI World SMID Cap Index is trading around 18 times and the valuation has increased by only one PE point over the past five years.


Some of the stocks he likes include US funeral group Service Corporation, Danish enzyme supplier Christian Hansen, Swiss private equity play Partners Group and US management consultant Genpact.

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