Two “Disruption” topics today:
#1: Tesla’s healthy earnings beat this afternoon and GAAP profits of +$1 billion got us to thinking about an age-old question: “As a shareholder, do you really want your disruptive tech company to show a large profit?”
There are arguments for and against, each with good examples. Amazon remains the poster child for the “big profits are for unnecessary” camp. The stock trades for 65x forward 12-month earnings, after all. Then there’s Apple, which in the last fiscal year made $57 billion – almost 3x Amazon’s annual profit – and has the largest market cap of any company on Earth.
This question has special relevance for Tesla because, well, technically it makes light vehicles and that’s not a sector one typically associates with either massive valuations or outsized profits. We can hear the Tesla bears saying, “Now that TSLA is solidly profitable its valuation will collapse because the market will be forced to value it on earnings rather than Elon Musk’s latest promises and every other auto stock trades for a much lower PE ratio”. We’ve covered the auto industry since 1991 so we’ll assure you that story is going to make the rounds.
The reason that’s wrong comes down to how equity markets actually value stocks; “earnings” matter but “where are cash flows being reinvested?” matters a lot as well. Amazon has established it can make money selling products online and providing cloud computing. It is spending essentially all its internally generated cash flows (aka earnings) on growing those businesses. Apple has gotten so profitable that it cannot spend all its earnings/cash flow on useful projects, so it buys back stock in addition to reinvesting in its business. Amazon has the higher multiple. Apple is worth more. Both have been strong long-term performers.
Takeaway: Tesla won’t be spending a dime of its earnings/cash flow on internal combustion engine technology (unlike every mainstream carmaker on the planet) and it has a decent lead in autonomous vehicle development as well. That’s why it will hold a higher multiple than old line car companies. We don’t have a particularly strong view on the stock aside from being perennially uncomfortable with the obvious key man risk. But we do know why it will never trade at the same valuation as any other “car company”.
#2: In what will be our last US Big Tech observation before these companies start to report earnings, we’ll look at the geographic revenue splits for Apple, Microsoft, Amazon, Google and Facebook. We’ve been discussing how different regions have been recovering from the global Pandemic Recession, so understanding where these 5 companies (23 pct of the S&P) make their money is important. The data here is from each company’s most recently completed fiscal year.
Highest international revenue percentage: Apple
- US: 40 percent
- Europe: 25 pct
- China: 15 pct
- Japan: 8 pct
- Rest of world: 12 pct
Highest percentage of US revenues: Amazon (data includes both AWS and retail):
- US: 68 percent
- Germany: 8 pct
- UK: 7 pct
- Japan: 5 pct
- Rest of world: 12 pct
Most even split and no non-US country making up +10 pct: Microsoft
- US: 51 percent
- Non-US: 49 pct
- (Note: this means China is less than 10 pct of MSFT revenues)
Big in Europe: Google
- US: 47 percent
- Europe, Middle East, Africa (EMEA): 30 pct
- Asia Pacific: 18 pct
- Other Americas: 5 pct
Big everywhere: Facebook
- US and Canada: 45 percent
- Europe: 24 pct
- Asia-Pacific: 23 pct
- Rest of World: 8 pct
Takeaway (1): as you hear about each company’s Q2 earnings results, keep these revenue splits in mind. A revenue beat at Apple means something different than a revenue beat at Amazon since their geographic sources of revenue are so different. EMEA (mostly Europe, we suspect) is more important to Google than total non-US revenues are to Amazon. Microsoft and Facebook are good proxies for global tech sector growth in their respective fields.
Takeaway (2): non-US revenue exposure is a large reason why these companies have the valuations they do. Their addressable market is essentially the world (ex-China for some, true) and their competitive advantages work equally well across the globe. It is intriguing to think where these revenue splits will be in 5-10 years’ time, barring any regulatory changes. At current valuations, the market is clearly saying “less US , a lot more international”.