When the Facts Change, I'll Change my Mind. The Facts Just Did. By Basil Ennab

It's so easy to be long the FANGs, but it's more difficult to be long for the right reasons. Sure Amazon is disrupting retail, FB and Google's mobile ad revenues are soaring and Netflix is growing and preserving subscribers at an incredible rate, however, it's worth taking a deeper look at what some of these companies are doing beyond their core businesses that make them such compelling long-term opportunities. When the ‘cloud’ was first introduced, it entailed using the power of the internet to leverage and connect massive data centers all around the world, mostly owned by big tech, as a means of storing data. Big Tech then turned around and started offering this service to enterprises everywhere, for an annual recurring subscription fee. That was just good business, it alleviated the pain and costs for organizations to hold these servers and store their data. Little did we know that the power of the cloud would have far greater ramifications than simply the provision of storage. The internet is the enabler of the cloud and has allowed organizations like Oracle, Microsoft, Amazon, Google, Nvidia, Intel and more to unlock far greater utility from this power source and expand their offerings to businesses.

This brings me to the point of departure for my hypothesis. The aforementioned companies now package and sell their solutions by developing software and harnessing the massive combined processing power of data centers, whose capabilities grow exponentially in line with Moore’s Law. As we enter this cognitive age of computing, businesses are better able to gain deeper insights into their business lines, their customers, and their supply chains. They are digitizing both structured and unstructured data. The cloud is the engine which helps organizations drive incrementally superior value from data sets. Machine learning and Artificial Intelligence have propelled analytics to strata that we have not seen before.

In today’s world, even the most casual observer of the stock market will point out that asset prices are too rich. Investors all around the world are anxious, far too many are anticipating a pullback. The bears are calling for a 10%, even 15% correction. Hedge funds have been one of the worst performing asset classes as a result. Up until a few days ago, I shared much of that anxiety. Then Q4 earnings happened; have we grossly underestimated the earnings power of companies? In short, probably yes. The FANGs continue to blow through even the most bullish of estimates, as are the banks, as are the industrial names and so many more. Hell, even IBM seems to be turning a corner. Part of it is excitement and vigour over impending tax reform. Consumer confidence is also riding high, but there was something in the water that I couldn’t quite wrap my head around. 

As John Maynard Keynes would say: "When the facts change, I'll change my mind". My mind finally did. It required three doubles and a single of scotch, coupled with some techno music to help my friend and I arrive at the following quasi-eureka moment (for the umpteenth time): what if markets are in fact not overpriced, what if they are just playing catch up? But what are they catching up to? They are catching up to a new reality, also in many respects the worst kept secret in the industry; companies are transforming in ways we have never imagined. They are better leveraging the cloud to gain TRANSFORMATIONAL insights about their businesses and the pigs, they get slaughtered, just look at GE.

Ultimately the power of the cloud will trickle into businesses from all walks of life. It will drastically change the current business landscape in North America, Western Europe, the Far East and then the rest of the world. Companies will likely be able to grow earnings meaningfully over the next decade, but how fast can they grow? They will grow their top lines with stronger data and better consumer analytics, they will grow more efficiently and shrink expenses, and as margins expand, so will multiples. Revenue growth will likely follow a J-Curve, come down, plateau and then rise, perhaps exponentially. 

Now the question becomes: beyond big tech and the usual suspects, who are the early adopters of this new wave? What insights can we draw from their experiences? How fast have they been able to grow earnings and what is their ROI over time? That is the billion dollar question. If we're able to capture a reasonably accurate estimate of the impact of tech on earnings going forward, then maybe, just maybe, we’d be able to hone in on leading indicators that will allow us to better gauge the growth of enterprises going forward, meaning better and more informed stock picks. For the first time in two years, I can comfortably say that barring any elevated political risk or some major disaster, then it is quite likely that the markets will continue accelerating to new heights, breaking so many records in the process. Multiples will continue to climb to keep up with this new reality. Is it irrational exuberance? Probably not, it is likely more informed exuberance. The FANGs have been the early beneficiaries and we can see it just by listening to their quarterly calls. The renewed excitement isn’t over their legacy businesses, but it’s about how they are pivoting their businesses for the future, and the future seems closer than ever before.