In tech we trust?

Jeremy: From semiconductors to software cloud platforms to artificial intelligence, technology isn't just reshaping industries, it is reshaping portfolios. And for the past decade, tech has not just been a sector, it's been the driver of wealth creation. Now, if you track the S&P 500, which accounts for nearly 60% of global listed equities, more than two thirds of the value created over the past 10 years has come from technology companies.

But we're also at a moment of profound uncertainty. Inflation, sticky interest rates and geopolitical tensions are putting pressure on markets. Valuations in the United States remain elevated, leading some to ask, are we in a bubble, particularly with the hype around artificial intelligence? Hello, this is No Ordinary Wednesday.

It's an Investec Focus Radio podcast where we take a deep and considered look at the forces shaping business, economies and markets. I'm Jeremy Maggs. Today I'm joined by Investec Investment Management's Global Equity Research Analysts from the United Kingdom, Zane Bezuidenhout and Dave Smith, and between them, they cover the full tech spectrum from semiconductors to software, hardware and also platforms.

They've just returned from the Deutsche Bank Tech Conference in California where they met with some of the world's most important companies, and they're going to help us unpack why tech still matters, what's hype and what is real, and where investors should be paying attention. Zane, Dave, welcome back to South Africa and to No Ordinary Wednesday.

Jeremy: Dave, let's start with the big picture if we can. If valuations are as stretched as some critics are suggesting, I've got to ask you why tech deserves attention today. Where's your head?

Dave: Jeremy, it's a good question. There's probably three key points. One is: tech is actually just too big to ignore. In 2015, go back 10 years in the S&P, which is the major index most people are going to be investing in on a global basis.

Seven percent of the S&P was tech, it's 48% today. You literally can't invest in global businesses unless you're willing to take some exposure to tech. So that's the first point. The second is most of the value creation In the last 10 years in global equities has come from tech. The work that Zane and I have done suggests two thirds of the value in the last 10 years has come directly from tech-related stocks.

And then the third point would be they are some of the best business models in the world that you can be exposed to and not everything's expensive. 

Jeremy: Basically what you're saying is it's the size, which I absolutely understand.

Jeremy: So Zane, from your coverage of the tech space then, I wonder what makes these businesses fundamentally different from other industries? 

Zane: Thank you, Jeremy. As Dave alluded, I mean these are some of the best businesses and best business models in the world that typically, although maybe one would argue not so much recently, given the investments they're making, but they're typically asset light businesses. Their growth is driven by innovation, research and development.

So they are rich in intellectual property and are asset light businesses, and they grow at incredible rates with this innovation that they generate. They typically also benefit from strong competitive advantages, scale economies that we've spoken about. Strong network effects in some cases. And then my personal favourite of competitive advantages is high switching costs. 

Some of these companies once they capture their customer, whether it's an enterprise or a consumer, they're in for life pretty much, you know? So these are fantastic business models and that's why we love them so much. 

Jeremy: So talking about fantastic business models, let's focus on the hyperscalers. So we're talking about the likes of Microsoft, Amazon, Meta, Google. They create, and this is staggering, more operating profit combined than the whole of South Africa's GDP.

That's almost worth repeating. Google alone generates revenue greater than South Africa's entire GDP. That's a staggering comparison.

Dave, what does this tell us about the scale and the dominance of these businesses? 

Dave: Good question. So there's probably two key parts to it. One is to what Zane alluded to, scale economies come through: the bigger these businesses are, the higher their margins are. The more cash they generate, the more that they can reinvest back into their own businesses and the bigger the moat around their business. Right? So that's probably the one.

The other is tech tends to lean itself towards winner takes most. A great example would be Google search. In search, Google has 90% of the online search market, so what you have is when you find the winner, they tend to take the lion's share of the profit and they tend to have really big moats.

Jeremy: So Zane, let's get into artificial intelligence. Obviously we need to go there. It's the next great platform shift following the evolution, I guess, of mainframe, PCs, the internet and mobile. So from your perspective, where are we on that journey right now? And perhaps more importantly for our audience, how do investors need to start thinking about this new paradigm, this new era?

Zane: Yes, and it is very much a platform shift. So maybe starting with the latter, it's how investors need to think about it. This is a structural change and it's a structural change in the way we do computing, and this was the Chat GPT moment.

Ultimately, what it showed was that accelerated computing as opposed to general purpose computing and to break that down, basically, accelerated computing is like parallel mathematics where general purpose computing is more linear mathematics. So the way we compute is going to change, and with artificial intelligence, it's gonna require more compute. 

So there's more and it's different and that is the direction that we are heading in and it's a big structural shift as we went through the previous evolutions that you alluded to. 

In terms of where we are in that shift and the companies that we've spoken to in our conference in California that we attended, and the calls that we listened to, it's very early innings.

Yes, it feels like since the rapid rise over the last three years that this might be long in the tooth, but a lot of these companies are saying that their supply cannot meet the demand from an AI perspective, and that there's still the supply gap from their side.

So it seems like we still in the early innings of particularly the infrastructure rollout behind artificial intelligence. 

Jeremy: But Dave, having said that, there's always risk on the horizon in one way or another. You've just returned from the Deutsche Bank Tech Conference in California. Are companies that you engaged with observed maybe a little bit more optimistic than fearful about an AI bubble?

Do you hear anything that makes you confident that this isn't a repeat of the dark days of 1999?

Dave: That's about right. So Microsoft's a great example in that case, in 1999 Microsoft traded at a 65 times forward p/e [ratio], it's 30-ish today, it's half of where we are.

We are not saying that there couldn't be some areas that might be worrying in times to come, but where we are today, as to Zane's point, is there's a lot of compute that is needed that the supply cannot be fulfilled right now. It's going to take some time.

If you talk to me in 18 months, two years, I think the conversation could change. But importantly, the current businesses we like to invest in, actually their multiples are really cheap.

An example of this is the Mag Seven, the ones that we like and we are overweight. It's not all of them. The average multiple is 25 times forward [p/e] for great companies generating huge cash flow, and we really like that they're growing fast. 

Jeremy: Let's talk about tariffs again in terms of risk for investors. What's the feeling, what's the perception on the ground? Is it a short-term noise factor or maybe a longer term shift in how the tech companies are valued? Zane, pick it up.

Zane: Yeah, it was actually an interesting point. I mean, when we go to these conferences, not only do we listen to what's said by these companies, but also what's not said.

And tariffs were hardly mentioned at this tech conference. It was more skewed to semiconductor companies in the semiconductor value chain. But I think what's maybe more relevant for them is less so tariffs, but is more around export controls and restrictions.

And we know there are geopolitical tensions or competitiveness, particularly between the US and China, and a fearfulness of allowing one to access advanced technologies and how those would then be used by, you know, their competitor.

So although those weren't explicitly discussed, we'd know from public markets that a lot of these companies have reduced their guidance to investors of what they can expect from China just given these export controls and restrictions. 

Jeremy: Dave, you also cover some companies in the robotics space. How long is it going to be, or how close are we to seeing robotics as a genuine investible theme beyond just, I don't know, the hyped headlines and maybe even the science fiction? 

Dave: So, I'm quite optimistic longer term. Yeah. I think it might be one of the solves for demographic issues, particularly in places like Europe, but we're probably minimum of five, probably closer to 15 years away, from a humanoid robot walking around your house doing the dishes and cleaning the floor.

Jeremy: From your lips, my friend...

Dave: But what's interesting is there are actually robotics companies you can invest in. Tends to be in medical areas. You can have a robot in one country, you can be a surgeon in another, to do a surgery. There's a whole bunch on warehousing where they're automating warehousing. 

And you could even argue to some extent, autonomous vehicles could be robotics companies, and that's coming fast. If you go to China or if you go to the US, you go to California, you can get a Waymo which doesn't have a driver and it's quite exciting.

Jeremy: So before we continue this conversation, I would like to take just a moment to tell you about something that is really close to Investec’s heart and that is Promaths. Promaths is a national programme that helps high school learners master maths and science - two subjects that can change the course of a life.

It began back in 2005 in Dobsonville in Soweto with the Kutlwanong Center for maths, science and technology, and it's now grown to 19 centres nationwide, 10 of which are funded by Investec.

This year we celebrate 20 years of Promaths and the scale of its impact truly is remarkable:

• 6% of all South Africa's maths and science distinctions in 2024 coming from pro math students.
• The programme has reached more than 28,000 learners who've earned over 13,000 distinctions, and many of them have gone on to become engineers, doctors and scientists.

Now, education isn't charity. It's an investment in South Africa's future, and you can be part of it. From just 100 rand you can support the Promaths bursary fund, helping top Promaths learners get to university or if you're part of a business, consider helping fund a Promath center in your community. 

Head to investec.com/promaths - you'll find the link in the show notes. Because every child who masters maths or science becomes more than a student. They become a problem solver and a nation builder. So let's help turn potential into purpose.

And now let's get back to our discussion on No Ordinary Wednesday.

Jeremy: Zane, back to you. Last year we saw a global scramble over the semiconductor shortages. Are you able to give us a sense of how that supply crunch is easing, and then again, pull the thread: What does that mean for investors? 

Zane: Yeah, so I mean, I think it's worthwhile casting our minds back to COVID and those dark days of lockdowns that disrupted global supply chains for every industry around the world, and semiconductors were one of the industries impacted by those shutdowns.

So we went through COVID where there was this supply crunch, you know, semiconductors go into everything that we use. I mean, it's the technology behind all technology and you get different types of semiconductors, some smarter than others. Your kettle's got a semiconductor in it, for example.

So naturally what these companies did, and you know, in this industry and other industries, is built up inventory to meet that supply gap. And then, you know, lockdowns ended and global economies tried to get back to normal and then we ended up actually with a supply glut.

So what we see in the non-AI space is, you know, a recovery or a  semiconductor market that's trying to write itself and recover, and we're seeing that recovery in different end markets, taking different times, the personal computing and the electronics market's doing all right in its recovery. Industrial end markets, you know, also finding its bottom recovering, automotive still oversupplied ultimately.

So you know, for investors outside of AI, you've really gotta look at the end demand and its end industry and ultimately it's about the demand-supply matching. 

Read Zane's article: Semiconductors - the brains powering the digital world

Jeremy: Dave, can we talk a little bit about investment strategy? You can argue, I guess, that this is a stock pickers market at the moment. Are there specific characteristics that you look for in tech companies that justify the premium valuation? 

Dave: Absolutely. So the risk with tech is always you overpay, you get bought into the dream and it never quite delivers. So what we tend to look for is businesses that have or are developing scale.

So they have the reach, they have client base that is large. We like moats, so they're not easily disrupted. We like high return on capital or at least the trend towards high return and capital. And then there are themes we like.

So we've talked about semiconductors and AI a lot. The implications of AI going online is that you and I are likely to do more online. So e-commerce is likely to become a bigger portion of people's baskets. We like that theme.

We like cybersecurity. We like the right part of the semiconductor value chain. We know there's huge supply constraints on the AI side, so you're trying to find business with the scale, businesses with moats and playing into themes where there's long-term compounding ability of top line and earnings.

Jeremy: So Zane, are there then parts of the tech universe that, in your opinion, are looking a little overheated right now? 

Zane: Yes. I mean, a big part of our job is to worry about what could go wrong, and there are parts, particularly with the evolution of artificial intelligence, there are emerging pockets around these core companies that do cause a little bit of worry, you know, whether it's some of these neo cloud businesses that are almost financed, not entirely, but a lot with leverage, to almost take surplus capacity that the hyperscalers themselves can't provide. 

You know, we're cautious of how private credit is getting into the space. And then also there are a lot of peripheral stocks that might be subject to speculative behaviour, so-called meme stocks.

So we're cautious around certain vulnerabilities and normally, you know, when one starts to see excessive leverage going into a certain part of the market, that's where we get a little bit more cautious. 

Jeremy: Alright, so that's the broad strategy then. Let me ask you both, are there specific stocks that uh, you're interested in?

Zane: Yes. In terms of my coverage, it's the obvious one and maybe that's where people roll their eyes given its run, and that's the world's largest company NVIDIA.

When you listen to Jensen Huang, the CEO, you understand what he is trying to build. He's not just selling a widget or an advanced widget, he's really trying to build an ecosystem.

He views his company as an architecture firm and the architecture firm on which all AI infrastructure is going to be built. So you can see he is trying to establish the company as the go-to infrastructure play, and then that's going to create high switching costs for those that use his products going forward because they'll become entrenched with his hardware, his software, and all the peripheral services.

So he is really wrapping his arms around the AI ecosystem. So we think that a company like NVIDIA has a lot of room to still go. 

Dave: So slightly tangential to that: My view is that Microsoft and Amazon might have the best business models the world's seen, but they're both a little bit further down the S-curve of growth. There's still very strong growth, but there are businesses that are replicating, for example Amazon, which are earlier stage.

So one of my favourites is a company called SEA. They are a Southeast Asian diversified tech player. They are very early stage in monetising their e-commerce business. They're half of that market. They have a dominant position.

They're building banks on the back of that because they know the client, they know the sellers. They can lend money with very low debts, and they have a really profitable gaming business. So I think this is one of those stocks that could do very well over the long term.

Jeremy: Which segues perfectly into my next question. Do you think we underestimate then opportunities in Asia and Europe? 

Dave: There are specific examples that we do, and the problem is, as Zane mentioned earlier, it is a bifurcated world if you are a Chinese tech player and the truth is there are two major tech hubs in the world. It's the US and it's China.

The rest of the world doesn't really have big giants. Europe's got one or two, but not too many. They can't play in each other's ecosystems world because the politics doesn't really allow for it. So when you think of the world's top 10 biggest companies, nine are tech companies, one is Saudi Aramco, so it's a very different beast. Eight of those are US.

The other one is TSMC which basically produces the semiconductors that go into the US guys. So the reason why the US is likely to have the biggest long-term winners at scale, there might be specific examples like SEA, once they've got scale.

Once you succeed in the US, you have enough revenue to be able to build moats and reinvest and take over the rest, do the similar thing to the rest of the world.

Two, they've got the talent. All the best engineers end up in the US and they have the capital. People are willing to fund these early stage businesses so they kind of have a competitive advantage in the global tech scene. 

 Jeremy: So, gentlemen, a fascinating and insightful conversation. Let's end with this then.

Jeremy: Zane, I'll come to you first. What's the single biggest misconception then that investors might have about the tech sector? 

Zane: Yes. I think, I mean, from my side, I would say the misconception is that AI is just hype and that the end is nigh, there has been a lot of popular commentary on how this is similar to the dotcom bubble. That's not what we see.

While there's always pockets of caution, it's not what we see from our discussions with these companies and the analysis that we do. So we think that is a big misconception.

We think the growth from these companies has been driven by strong fundamentals and we think the runway for further growth is long.

Jeremy: What about you, Dave? 

Dave: That it's too expensive to invest in now, that the price isn't worth the earnings - the juice isn't worth the squeeze.

I'll give you an example of META , Instagram, Facebook, WhatsApp. They traded a 20 times forward p/e. One of the South African champions, Shoprite circa 17, but META produces a return on equity in the forties and fifties. Shoprite is in the teens.

META’s long-term growth rate is higher. So I'd argue if you are a discerning investor, which hopefully we are, you will find some gems which are not overvalued and actually offer phenomenal long-term compounding for investors. 

Jeremy: Dave Smith, Zane Buizenhout, thank you so much for joining us on this edition of No Ordinary Wednesday.

Just before I bid you farewell, I do want to tell you that this episode has been filmed, so if you want to re-watch any parts of it, you can do so on Investec’s YouTube channel.

And as always, if you've enjoyed this conversation, please follow Investec Focus Radio SA wherever you get your podcasts, and we will be back in a fortnight with more analysis on the major economic trends that are shaping our market.

Thank you so much. 

Zane and Dave: Thank you for having us.

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