Should investors WAAAX on or WAAAX off after the brutal sell-off in tech stocks?
WAAAX stands for Wistech Global, Afterpay Touch Group, Altium, Appen and Xero – Australian tech stocks that have soared in the past few years. They are our equivalent to the famed US FAANGs (Facebook, Amazon, Apple, Netflix and Google, via its parent Alphabet)
The “WAAAX one or off” line refers to a scene from the cheesy eighties movie, The Karate Kid, where the Japanese instructor Mr Myiagi tells his pupil to wax a collection of antique automobiles, thus performing a set of repetitive exercises to learn discipline and patience.
If only investing was that simple. Knowing whether to buy (WAAAX on) or sell (WAAAX off) Australia’s new breed of tech stars is challenging even the best fund managers.
To recap, the WAAAX stocks soared to nosebleeding levels because they built globally scalable technology businesses that had capital-light business models. Like the FAANGs, investors could not get enough of our star tech firms.
Wistech soared from a 52-week low of $9.18 to a 52-week high of $25. Afterpay rocketed from $4.70 to $23, using the same parameters. Appen surged from $5.20 to $16; Altium from $11.56 to $30.51; and Xero from $25.82 to $52.57, using Morningstar data.
WAAAX valuations at the peak made one’s head hurt. Wistech, for exsample, traded on a forecast Price Earnings (PE) multiple of more than 100 times, such was the market’s faith that it could deliver lightning-fast earnings growth and justify the valuation.
Afterpay, essentially a clever lay-buy business that earns a chunk of its revenue from late fees, also traded on a triple-digit PE at one point. For comparison, the average PE multiple of the ASX 200, which includes companies far more established and profitable than the WAAAX, is about 15.
Experienced investors knew that WAAAX hype and valuations were in bubble territory and took profits. Then, global sharemarkets shuddered in October and valuations slid. Tech stocks that soared ever higher came back a little closer to Earth, if not crashing down.
The WAAAX stocks have broadly lost a third of their valuation (from peak prices) since the sell-off. Tech bulls say it’s time to buy WAAAX stocks, particularly as it looks like the global equities correction has lost steam and markets are starting to recover.
I am not convinced. For context, I don’t see the latest sell-off as another time to “buy the dip”, nor do I believe equities markets will race back to previous highs. This sell-off, particularly in Australia, is different and on balance I expect markets to grind sideways or drift lower.
As I wrote last week for The Bull, I am getting more concerned by the day about Australia’s housing slowdown. Auction clearance rates, an early indicator of property-price movements, have slumped. House price falls are accelerating. Economists who previously expected a mild property slowdown are forecasting peak-to-trough falls of 20 per cent.
If those forecasts hold (I think falls could be a little worse than that in Sydney and Melbourne), consumer confidence and retail spending will be hammered. Australia’s economic outlook looks more fragile than it has in many years, which bodes poorly for our sharemarket.
Economics aside, WAAAX valuations still look overcooked, even after price falls. Granted, these stocks are hard to value: but does a loss-making company with a few years of history as a listed entity deserve to trade on a PE multiple above 100? That’s an incredible leap of faith.
Don’t get me wrong: the WAAAX companies are terrific businesses: they have clever business models, fat margins, recurring revenue, are highly scalable and well run. Most of them are genuinely global businesses that are addressing a market many times larger than in Australia.
But every stock has its price. When investing in technology, it pays to look globally rather than only domestically. That’s not to downplay the potential or performance of Australia’s listed tech sector. Rather, the lack of choice in large tech stocks in Australia relative to the United States or other offshore markets, arguably inflates valuations of star ASX-listed tech stocks.
FaceBook trades on a forward PE of about 18 times, consensus estimates show. Apple trades on 16 times. Amazon, which could be the mother of all tech stocks and redefine global retailing and logistics, is on 57 times. Alphabet is on 22 times and Netflix is on 68 times.
You get the drift. The world’s great tech companies are, on average, on valuation multiples significantly below Australia’s WAAAX stocks. They may no longer deliver the same stratospheric earnings growth of previous years, but give me Amazon over Afterpay any day. The WAAAX stocks are not even close to being in the same league (barely any companies are).
Readers who want to add tech exposure after the sell-off should a) look globally, b) take a diversified approach, and c) consider smart-beta Exchanged Traded Funds (ETFs).
I like the ETFS Morningstar Global Technology ETF (ASX Code: TECH), which tracks the performance of the Morningstar Developed Markets Technology Moat Focus index.
TECH has two traits that differentiate it from similar ASX-quoted, tech ETFs. First, unlike similar ETFs that are weighted by company capitalisation, TECH uses an equally weighted index – each stock, regardless of size, has the same index weight. That can drive performance, but adds risk.
Second, the index includes tech companies that Morningstar believes have the strongest competitive advantage (moat) and are attractively priced. Unlike ETFs that passively replicate an index, TECH relies on active management in its index methodology.
The benefit, in theory, is TECH does not include in its index technology stocks that are wildly overpriced (as is the case with passive ETFs that have to own stocks in the underlying index). This is an important safeguard, as is having Morningstar analysts choosing the stocks.
TECH has returned 20.6 per cent annually since inception in early 2017. That’s despite a 13 per cent fall in the past month.
There’s no rush to buy TECH, other tech-focused ETFs or tech stocks directly. But keep an eye TECH, which is a low-cost, diversified tool to add tech exposure during market corrections.
Chart 1: ETFS Morningstar Global Technology ETFSource: The Bull
• Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at October 31, 2018