How Buffett and Apple get to the core of technology investing

A difficult year for the technology giant Apple is taking an interesting turn with the news that legendary ‘value’ investor Warren Buffett has bought a stake worth just over $920 million at the prevailing price of $93.88.

Apple’s shares have received a welcome boost after the Buffett swoop

Source: Thomson Reuters Datastream

Apple’s second-quarter results, to the end of March, featured the first year-on-year drop in earnings since 2013, the first drop in group sales for more than a decade and the first ever decline in iPhone sales.

There are few worse investments than a growth stock that goes ex-growth and Apple’s 30%-plus fall from last year’s peak reflects that. Equally, Buffett’s preference for companies with good brands, market-leading positions, robust cash flow and strong balance sheets that trade on sensible valuations helps to explain why the Sage of Omaha has piled in.

Advisers and clients will not have time to study one stock in any depth, even if it is one of the world’s top five by market cap, but many of them may be interested in technology stocks.

In a low-growth world any firm capable of generating rapid organic profit increases will be highly prized and technology is one logical area to look.

But Apple’s 2016 stumbles and Buffett’s purchase raise interesting questions about how advisers and clients can assess technology or growth-focussed funds, if they feel they are an appropriate asset class to consider within the realms of a balanced portfolio. America’s leading tech-heavy index, the NASDAQ Composite, is making heavy weather of getting back to last year’s all-time highs as the profit warnings start to come thick and fast from tech firms of all shapes and sizes.

The tech-heavy NASDAQ Composite index has lost a little momentum of late

Source: Thomson Reuters Datastream

Wheel of fortune

The smart phone and tablet computer are just the latest developments in a never-ending cycle of technological evolution. Each turn of the wheel has brought feast for a select few winners, who 'got it' and had first-mover advantage – and also famine for those whose offerings were overtaken and left looking old hat.

  • In the 1960s, IBM dominated mainframe computing.
  • In the 1970s, Big Blue’s predominance came under attack from the BUNCH companies – Burroughs, UNIVAC, NCR, Control Data and Honeywell.
  • In the 1980s that quintet fell by the wayside when the minicomputer took over, as DEC, Wang Labs, Prime Computer and Data General became the new tech industry darlings.
  • The early 1990s saw the advent of the early personal computers (PCs), a market bossed to great effect by Apple, Tandy and Commodore.
  • The late 1990s brought another shift, as the Wintel (Microsoft Windows-Intel microprocessor)-fired desktop and laptop personal computers took over, propelling Compaq, Gateway, NEC/Packard Bell and Dell into the spotlight, although the mobile phone began to creep up on the rails, a trend which temporarily left Finland’s Nokia as king of the technology hill.
  • The 2000s brought nemesis to Nokia which fell off its perch with frightening speed as smartphones and then netbooks took over, to the benefit of a completely reinvented Apple and Korea’s Samsung grabbed the lead.
  • After 2010 the tablet computer became the latest consumer darling although its time at the top looks destined to be a short one, as sales are already sliding at Apple and the price is simply too high to facilitate the mass adoption enjoyed by mobile phones. In the business area, demand for servers and enterprise infrastructure has boomed as corporations have sought to optimise storage, use the cloud and manage a deluge of data more efficiently, helping Intel, IBM and Dell, amongst others, in their efforts to reinvigorate their growth profiles. Social media and the internet also continue to change how information is disseminated, digested and used by consumers – a trend which Facebook, Alphabet and Netflix are driving hard.

A few firms enjoy their day in the sunshine and they make plenty of hay (or profit and cash flow) – but the problem is very few stay at the top for more than five or ten years and once they fall, they fall hard (and in many cases, as suggested by the list above, pretty much disappear altogether).

The first chart below shows Apple’s sales and operating profit growth, year-on-year and the second volumes and growth rates for iPhones and the third the same for its iPads – note that iPad volumes peaked at Christmas 2013.

Apple needs to rebuild sales and profit growth momentum …

Source: Company accounts. Refers to company's financial year - Q1 is calendar Q4

… as iPhone sales slow ahead of new product launches …

Source: Company accounts. Refers to company's financial year - Q1 is calendar Q4

… and iPad volumes languish way below 2013 highs

Source: Company accounts. Refers to company's financial year - Q1 is calendar Q4

Ripple effect

Again, the comings and goings at one stock will be of modest interest at best to advisers and clients. But Apple’s size means it has huge impact on the technology foodchain, as silicon chip makers, precision instrument experts, circuit board manufacturers and others all benefit when the Californian giant does well – and catch a cold when its fortunes are not so good.

A number of US and Asian silicon chip companies, such as Qorvo, Cirrus Logic, Skyworks, Broadcom, NXP, Texas Instruments, TSMC and others have issued disappointing earnings or profits guidance as Apple has hit its growth bump. This has weighed on this column’s old friend, the Philadelphia Semiconductor Index, or SOXX, of which the UK’s ARM is also a member.

ARM is a member of the Philadelphia Semiconductor Index

Source: Thomson Reuters Datastream

All of these firms will be hoping the launches of the iPhone7 in September of this year and iPhone 8 in September of next bring some good news, although Apple’s problem seems to be a lack of killer new innovations and upgrades – at least relative to the quantum leap on functionality offered by the earliest iPhones, especially as the Watch is barely mentioned any more.

Wider growth gap

But the Apple foodchain is not the only one going a little hungry.

A number of big-cap technology names were hammered after they delivered disappointing earnings reports for the first quarter or weaker-than-expected earnings guidance for the second.

Alphabet (Google as was), IBM, Intel, Microsoft and Oracle all came in with figures or outlook statements which missed forecasts and in many cases their share prices took a drubbing. Only Amazon and Facebook really offered tech bulls any succour by beating forecasts, as key tech markets like smartphones, computing, telecom equipment and even automotive began to show some signs of slowing down.

Technology is therefore cyclical – but the cycle is one tied to innovation, new releases and product advantage rather than the broader economy.

The need to follow multiple product cycles makes technology investing a difficult area for time-poor advisers and clients, despite the potential for capital appreciation from winning tech stocks. This is where specialist help from an experienced fund manager can add value to those who have a sufficient appetite for risk and a desire to seek out capital appreciation.

According to Morningstar, there are ten Exchange-Traded Funds which track baskets of technology stocks on a global basis and another three which follow the tech-laden NASDAQ 100 benchmark. The five best performers among those dedicated to technology with a five-year lifespan are listed below (even if some of them are not very big).

Best performing technology-dedicated ETFs over the last five years

Source: Morningstar, for Sector Equity Technology category
Where more than one class of fund features only the best performer is listed.

Meanwhile, two investment trusts provide dedicated exposure, albeit with a heavy slant toward the USA. Polar Capital Technology is one and the other is Allianz Technology.

Best performing technology-dedicated investment trusts over the last five years

Source: Morningstar, for Sector Specialist: Tech Media & Telecoms category
* Share price. ** Includes performance fee

A further name to research here is Baillie Gifford’s Scottish Mortgage, which focusses on global growth stocks in its quest to provide above-average returns over a five-year rolling period. Interestingly, Apple is not a top-ten holding, whereas internet plays, Baidu, Tencent, Facebook, Alibaba and Alphabet are, alongside electric car pioneer Tesla.

Scottish Mortgage has a strong growth-stock bias

Source: Thomson Reuters Datastream

There is further choice on offer from a wide number of specialist open-ended funds.

Best performing technology-dedicated OEICs over the last five years

Source: Morningstar, for Sector Equity Technology category.
Where more than one class of fund features only the best performer is listed.

As a final point, advisers and clients could back Buffett’s judgement and buy into Berkshire Hathaway stock, although the $212,530 per share price tag may deter some. Two of his top 20 holdings are now tech companies – IBM and Apple.

His first pick, IBM, has yet to cover itself in glory since his initial purchase in the first quarter of 2011 in capital terms, although the company has paid out dividends worth more than $20 a share and run a handsome share buyback programme in the meantime.

IBM has yet to prove itself to be a good pick for Buffett

Source: Thomson Reuters Datastream

AJ Bell Investment Director

Russ Mould’s long experience of the capital markets began in 1991 when he became a Fund Manager at a leading provider of life insurance, pensions and asset management services. In 1993 he joined a prestigious investment bank, working as an Equity Analyst covering the technology sector for 12 years. Russ eventually joined Shares magazine in November 2005 as Technology Correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media, by AJ Bell Group, he was appointed as AJ Bell’s Investment Director in summer 2013.