Robin Geffen

Finding the FAANGs of the future

Robin Geffen

The company Cadabra was incorporated in July 1994 in Washington state. This might mean very little, if anything, to you until I say that a few months later the name of the company was changed to Amazon.com. Twenty-six years later, the founder Jeff Bezos is now the world’s wealthiest person and Amazon’s shares are each worth more than $3,000 (as at 31 July 2020).

Amazon, of course, is one part of the famous FAANG stocks, along with Facebook, Apple, Netflix and Google (Alphabet). In recent years, these titans have been the biggest drivers of stock markets both in the US and globally. This has led in turn to this small number of companies becoming an ever-increasing proportion of the stock market, as investors, passive funds and ETFs have continued to pour money into buying FAANG’s shares.

These mega tech companies now comprise nearly a fifth of the US market and Microsoft’s market cap is now close to the entire market cap of the largest 100 publicly listed companies in the UK.

The question facing investors is how much of an allocation do they continue to make to these mega caps and whether now is the time to also focus on global small caps and trying to find the next FAANG; can investors discover the 2020 equivalent of Amazon in 2000 when one of its shares was worth $2 or less? We believe there are a number of reasons why investors should consider global small caps.

The first is because of the growing valuation gap between large and small caps, which has left the latter relatively cheap in our view. This is because global small caps have underperformed large and mid caps in 2018, 2019 and since the start of 2020. Over the past four years, the MSCI Large Cap World Index has returned 49.08% whereas the MSCI Small Cap Index is only up 27.53% to 31 July 2020. The current calendar year has so far been the worst relative performance for global small caps since 2004.

This is counter to the trend of the past 20 years, however. Since the start of 2001, the MSCI World Small Cap Index has returned 433.98% against 217.15% by the MSCI AC World Index. We believe the underperformance of the past three and a half years has presented buying opportunities among global smaller companies on valuation grounds. This opportunity is enhanced by the fact that global small caps have relatively few followers among brokers and therefore are often underappreciated.

Another attraction is the fact that smaller companies lead economic recoveries, including following the Global Financial Crisis, and we have no reason to believe it will be different this time when the world finally moves beyond Covid-19. The unprecedented technological change we have been experiencing during the pandemic creates the chance for investors to find the future FAANGs.

There are a number of filters we use in determining which global small caps to buy. We want to invest with innovators and disruptors, not followers. Companies must have management that will successfully grow the businesses when they become mid and large caps, not just when running a small company. We look for companies with a discernible edge and those that are responsible with their cash.

Software is a favoured sub-sector for us. Software products have been uniquely positioned in the pandemic in that they have served mission critical functions for businesses to continue to operate.

A great example of this in the communications software sub-sector is one of the long-time holdings in our Liontrust Global Smaller Companies Fund − RingCentral. The company has been thriving off a trend to shift processes to the cloud and avoid unnecessary equipment capex by allowing employees to use their own, more familiar, devices for work purposes. The outlook for the company pre-Covid-19 was significantly boosted after RingCentral announced a partnership deal with Avaya that gave it exclusive access to 100 million seats that Avaya sells to; it is worth noting that RingCentral had only 2 million seats prior to the deal.

Another long-term holding in the Liontrust Global Smaller Companies Fund is Twilio, which provides a communications API platform for software developers. If you’ve received a text, call or email from a company through an app or webpage, it is likely that it used a Twilio plug-in solution. With the rising need for an online/virtual presence for all businesses, Twilio stands to benefit by providing the necessary tools that developers need to be able to provide this service.

The potential reward of finding such companies when they are small is shown by the growth of Twilio. In December 2017, Twilio’s share price was $26.07 and at the time of writing this article (31 July 2020) it had grown over 10 times to $277.42.

We believe global small caps are also worth considering now because of their relatively cheap valuations, the fact that far fewer brokers follow them than mid and large caps and their potential for economic growth as we come out of this crisis.

Finding the FAANGs of the future

Source: FE Analytics as at 31.07.20. Past performance is not a guide to future performance

Liontrust Insights

 

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Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in funds managed by the Global Equity (GE) team may involve investment in smaller companies - these stocks may be less liquid and the price swings greater than those in, for example, larger companies. Investment in funds managed by the GE team may involve foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The team may invest in emerging markets/soft currencies or in financial derivative instruments, both of which may have the effect of increasing volatility. Some of the funds managed by the GE team hold a concentrated portfolio of stocks, meaning that if the price of one of these stocks should move significantly, this may have a notable effect on the value of that portfolio.

Disclaimer

The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Tuesday, August 18, 2020, 9:33 AM