Is your portfolio on the right side of digitalization?


Doug Rao, Portfolio Manager – Janus Henderson Investors

A woman attends a video meeting on her laptop

 

Key Points

  • The digitalization trend has created a rift between companies on the right and wrong sides of technological disruption.
  • The COVID-19 pandemic has accelerated investments in certain areas of technology.
  • Investors may benefit by focusing on competitively advantaged companies with strong balance sheets and the ability to generate capital returns.

The use of digital technologies is generating new revenue and transforming businesses globally. Diverging new- and old-economy companies, the digitalization trend has implications investors may want to consider with their financial advisor.

Tech stocks driving market performance

The market capitalization of Facebook, Amazon, Apple, Netflix, Google — sometimes referred to as the FAANG stocks — along with Microsoft (MSFT) and Tesla (TSLA) is larger than the combined companies in the European Union, China, Japan or the United Kingdom.1

In the first half of the year, these stocks returned +26.50% vs. the S&P 500® Index return of
-3.08%.1 They maintain strong balance sheets, generate robust free cash flows and have been resilient (or benefited) during the pandemic.

We believe this market leadership highlights the rift between companies on the right and wrong sides of digital disruption.

 

Pandemic-driven technology themes

A number of technological trends have accelerated and are likely to strengthen over the coming months and years.

For example, e-commerce has gained traction as a percentage of total consumer spending and continues to outperform expectations. It grew 72% year-over-year in the United States in June.2 This includes new demographic groups such as older consumers as well as slow-to-adopt industries like grocery and education. In our view, consumers who adopt online purchasing rarely return fully to brick-and-mortar options, which should help drive longer-term growth in e-commerce.

Streaming video consumption has picked up substantially. Current gains may enable pricing power in the future, increasing the value of streaming platforms. Furthermore, platforms like Netflix and Disney+ don’t rely on advertising revenue, so they have an advantage as advertising budgets tighten.

Digital advertising platforms have also gained share. For instance, e-commerce companies generally spend a greater portion of their marketing budget toward online advertising than do traditional stores. As e-commerce grows, online advertising will likely grow.

As more employees work from home, cloud computing and software-as-a-service solutions (e.g., Dropbox and Salesforce) have grown rapidly. Since productivity has remained high during the pandemic, corporations will likely begin to analyze the potential benefits of a permanent work-from-home environment.

Public cloud platforms — infrastructure for innovation

These technological trends wouldn’t exist without the cloud infrastructure that Amazon Web Services, Microsoft Azure Cloud, Google Cloud Platform and other large tech companies are building. The cloud offers cheaper, more agile and more secure enterprise information technology than on-site options.

While the platforms have grown tremendously in the last five years, the buildout of the cloud has much room to develop further, according to our research. We believe investment in cloud infrastructure has a long runway of growth, with 50% - 70% of demand potentially consolidating across the three current platform leaders.3 This is the result of barriers to entry, including high capital requirements and sophisticated software development talent.

The importance of competitive advantages

These digitalization themes are playing a vital role in the transformation of the U.S. and global economies. While being on the right side of technological trends is important, it’s also essential to identify companies with a business model advantage. There can be promising tech trends, but without a business model advantage a company may not sustain growth and generate appropriate returns on capital over the long term.

In this environment of technological change, we believe it’s important for investors to work with their financial advisor to maintain a diversified portfolio that supports their goals.

 

1 Source: Bloomberg, as of June 30, 2020. Bloomberg is an independent investment research company that compiles and provides financial data and analytics to firms and investment professionals. It is not affiliated with Ameriprise Financial, Inc.

2 Source: Bank of America Global Research, Little deceleration in eCommerce growth in August, Aug. 21, 2020.

3 Source: Janus Henderson proprietary internal research (not released to the public), as of June 30, 2020.