The FAANG (Facebook, Apple, Amazon, Netflix and Google) companies have become investor darlings, delivering steady earnings growth (and positive earnings momentum), while the sector is one of the least regulated. However, the sectors have faced increased scrutiny from regulators and governments with the introduction of new taxation policies.
Tax advantage
Big Tech companies have for years avoided full taxation. The European Commission claims that ‘traditional’ companies face a 23.2% tax rate on average but ‘digital’ companies pay a mere 9.5% thanks to legal loopholes and tax policies. Regulators and governments have started to look closely at the sector, with different approaches in the US and Europe.
Tech companies are full of cash
Since the Great Financial Crisis in 2007, which put the regulatory spotlight on financial companies, tech companies have been able to accumulate wealth as the world has become more connected and digital. Often with foreign subsidiaries located in tax-haven countries, these companies have amassed an enormous amount of unrepatriated foreign earnings.
As of 2017, tech companies accounted for 76% of S&P 500 total cash & cash equivalents held abroad, or the equivalent of $600bn, concentrated largely with the FAANG companies (Facebook, Apple, Amazon, Netflix and Google). Apple has a big piece of this pie, with $252bn.
M&A and buybacks
The goal of US tax reforms has mainly been to boost job creation and capex/R&D spending with the hope of a positive ripple effect on US economic growth.
Technology companies have been by far the largest drivers of buybacks within the S&P 500 over the past two years, with $272bn of gross buybacks – out of $840bn - as of the second quarter of 2019. At the same time, their cash holdings have been declining from record-high levels.
A digital tax
While the fines from the European Commission have been focused on antitrust penalties, European governments are currently pushing for a digital tax. Currently, the lack of coordination at the European level means that initiatives are being gradually implemented at the country level, with France and Hungary leading the march.
Conclusion
Earnings momentum is key for US tech companies and massively contributed to their outperformance versus the broader US market. Since 1998, US tech earnings momentum (year-on-year change in 12m forward EPS expectations) has been above S&P 500 earnings momentum 71% of the time, in 187 months out of 260. Going forward, a resolution of the trade war as well as addition monetary stimulus from central banks are imperative for the tech sector to continue generating positive returns for shareholders.
Disclaimer:
This article was issued by Kristian Camenzuli, Investment Manager at Calamatta Cuschieri at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.