The U.S. market is reaching new highs in 2017, with Apple (ticker: AAPL) joining the FANG stocks — Facebook ( FB), Amazon.com ( AMZN), Netflix ( NFLX), and Google (Alphabet) ( GOOG, GOOGL) — as significant contributors to the market rally. Comparisons to the dot-com mania of 1999 are inevitable, as is speculation that there is a bubble that is about to burst.
However, there are notable differences between today and 1999, perhaps alleviating concerns about a potential repeat of the market correction that followed the dot-com boom.
Many high profile companies from the dot-com era are no longer in business or are less important, victims of flawed business models or competitive forces. Nokia ( NOK), Palm and BlackBerry ( BBRY) were trend-setters in the early days of smartphones and personal digital assistants, but were unable to retain their market leadership against innovative competitors. Cisco Systems ( CSCO) and Nortel were among the equipment providers that benefited from the rapid growth of the internet, but lost momentum when faced with the dot-com bust and vigorous competition.
Dr. Koop.com, pets.com and the globe.com are among the companies that came public at an early stage of development, perhaps lacking the business plan or revenue model to weather the dot-com bust. Microsoft Corp. ( MSFT), Cisco, Intel Corp. ( INTC) and Qualcomm ( QCOM) are among the dot-com era companies that continue to be technology sector leaders today, though each company faces slowing growth and transition challenges.
[See: 10 Ways to Invest in Driverless Cars.]
Contrasts between today’s technology sector and the dot-com era are significant, including differences in business models, growth prospects and valuations. Many of today’s top-performing technology companies are “platform” companies with an established ecosystem in which companies plug into the platform to add incremental value or gain access to a network of potential customers.
Apple provides a striking example of how dot-com era business models have evolved. In 1999 Apple was primarily a computer company, selling Apple hardware and software in a highly competitive marketplace. Today, Apple is a ubiquitous platform, providing e-commerce, computing, communication and entertainment to hundreds of millions of customers. The installed base of and extensive library of apps tailored to Apple’s ecosystem provides significant barriers to entry, and disrupts legacy business models in numerous industries.
Apple, Amazon, Google, Facebook, Alibaba Group Holding ( BABA) and Tencent Holdings are among the companies that benefit from scalable network effects in which “users beget more users.” Successful platforms have a very different economic model than was the case for the dot-com era winners, in that a limited number of winners gather the majority of revenues and benefit from the barriers to entry created by network effects.
“Winner take all” or “winner take most” markets often feature higher profit margins, cash flows and pricing power than markets with more competitive structures. Technology stocks represented about one-third of the Standard & Poor’s 500 index in 2000, before falling dramatically after the dot-com bust.
Technology stocks represent about 22 percent of the index today, rising meaningfully in important from recent levels. The concentration of the S&P 500 in technology concerns some, but it is important to recognize that the technology sector today is far more diverse than in the dot-com era.
Apple could be classified as a consumer discretionary company, joining Amazon among companies that capture a meaningful share of consumer spending. Google and Facebook are advertising powerhouses, benefiting as digital advertising increasingly replaces traditional television outlets in corporate ad spending. MasterCard ( MA) and Visa ( V) are payment processors, providing critical infrastructure to the financial services industry.
Apple’s slowing growth is well documented, given the challenge in finding a next act with the kind of impact as the iPhone, iPod, iPad, iMac and the App Store. However, there is still rapid growth in many segments of the technology universe. Thanks to Amazon, many people no longer run errands at night or on Saturdays. However, global e-commerce is still less than 10 percent of total worldwide retail sales.
Potential growth for e-commerce is high, as is the threat to traditional brick-and-mortar retailers.
[See: ETFs That Allow You to Invest in Space.]
Amazon’s acquisition of Whole Foods Market ( WFM) may create additional growth opportunities, while threatening grocery industry incumbents. Amazon is also a leader in cloud computing, competing with Microsoft in a rapidly growing industry. Amazon isn’t alone in capturing high-growth opportunities, and growth isn’t confined to the U.S.
China represents a high-growth opportunity for social media, advertising, and e-commerce. Alibaba, Tencent, Baidu ( BIDU), JD.com ( JD) and Ctrip.com International ( CTRP) are among the companies taking aim at the rapidly growing Chinese market.
Valuations during the dot-com era reached dizzying levels, with the price-earnings ratio for the technology sector exceeding 50 percent in 2000. Amazon and Netflix draw the most attention for their lofty valuations today, with both trading above 100 times estimated earnings for next year. The valuation of Amazon has been controversial for years, but the company’s staggering growth and expansion into new markets has converted many naysayers.
Although Amazon and Netflix are valued at controversial levels, the technology sector as a whole is trading far below the heights of the dot-com era. At an upper-teens forward price-earnings multiple, technology sector valuations are comparable to the slow-growth, high-dividend utility sector and are below that of the consumer staples sector.
Valuations of some popular consumer staples stocks don’t seem cheap, with McDonald’s Corp. ( MCD) and Coca-Cola Co. ( KO) trading at forward P/E of about 22, while PepsiCo ( PEP) and Procter & Gamble Co. ( PG) trade at a forward P/E of about 21. Alphabet, parent of search-engine Google, trades at a forward P/E of 24, while Facebook trades at a multiple of nearly 26. At a slightly higher earnings multiple, Alphabet and Google offer considerably higher (though more volatile) growth prospects than the consumer staples stocks that have been favorites for dividend-oriented investors.
Disruption from technology-oriented competitors isn’t going away, threatening legacy business models in most economic sectors. Investors may disagree about whether a company such as Netflix has a sustainable competitive edge against incumbents such as Comcast Corp. ( CMCSA) or Walt Disney Co. ( DIS), but investing in an incumbent without considering the threat or opportunity from Netflix is short-sighted.
Similarly, Amazon may never “grow” into its valuation, but investors should consider the Amazon effect before investing in a retailer that seems to be cheap on the surface.
The contrast between today’s technology universe and the dot-com era is dramatic, and investors who have been avoiding technology should revisit their thinking. Technology stocks, and the market as a whole, may be vulnerable to a correction, but the long-term prospects for technology are favorable as economies previously dominated by manufacturing increasingly become technology-centric.
[See: 10 Great Tech ETFs That Stay Under the Radar.]
Disclosures: Investments in securities are not insured, protected or guaranteed and may result in loss of income and/or principal. This communication may include opinions and forward-looking statements. All statements other than statements of historical fact are opinions and/or forward-looking statements (including words such as believe, estimate, anticipate, may, will, should and expect). Although TFC Financial Management believes that the beliefs and expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such beliefs and expectations will prove to be correct. Unless stated otherwise, any mention of specific securities or investments is for hypothetical and illustrative purposes only. Adviser’s clients may or may not hold the securities discussed in their portfolios. Adviser makes no representations that any of the securities discussed have been or will be profitable. Nothing in this communication is intended to be or should be construed as individualized investment advice. All content is of a general nature and solely for educational, informational and illustrative purposes.
More from U.S. News
20 Awesome Dividend Stocks for Guaranteed Income
6 Things to Know About Mark Zuckerberg’s Manifesto
10 Important Investments Before Having a Baby
Are Tech Stocks Partying Like It’s 1999? originally appeared on usnews.com
