Quality tech companies to drive 2024 returns

IN THE era of digital transformation, startups are often touted as having a significant edge over established giants due to their agility and streamlined operations. This agility allows them to innovate rapidly and adapt to evolving market trends.

However, the prevailing reality challenges this perception.

Contrary to popular belief, the largest US companies have strengthened their dominant positions over time, showing limited vulnerability to competition from smaller, newer players. Essentially, incumbents have become more, not less, secure.

For instance, since a decade ago, the market capitalisation of the Big Tech companies (Apple, Microsoft, Amazon, Alphabet and Meta Platforms) as a proportion of the entire S&P 500 has steadily increased from less than 10 per cent in 2013 to more than 20 per cent by the end of 2023.

Nowadays, more than 50 per cent of global digital ad spending goes through Meta or Alphabet, up from 38 per cent 10 years ago. In the realm of search, Google commands a market share of over 90 per cent globally – an unassailable lead it has maintained since at least 2009. More than 60 per cent of the world’s cloud infrastructure is controlled by just three companies – Amazon, Microsoft and Alphabet.

There are compelling reasons to anticipate that these entrenched industry leaders will continue to maintain their dominance in the foreseeable future. Consequently, investing in such high-quality, established companies remains a wise long-term strategy, irrespective of the economic climate.

Competitive advantages ensure dominance

The increasing influence of these Big Tech companies in the global economy can be attributed to their competitive advantages – such as strong brand names, massive scale and high customer switching costs. These factors enable them to fend off competition from would-be disruptors and preserve their margins.

In certain industries, patent protection and regulation limitations also make it expensive for new competitors to enter the market. In addition, their dominance in their respective industries has also led to greater pricing power and higher margins over the years, allowing them not only to increase revenue, but also earnings.

While some investors may argue that the incumbents would eventually be disrupted by smaller and more innovative companies, this may not be the case for today’s Big Tech companies, at least not in the near future. Today, some of the most durable moats are built on advantages such as network effects and data within a product or service ecosystem – which is precisely what these Big Tech companies are known for.

By having wide network effects and distribution channels, as well as a lack of real competition, these quality Big Tech companies are likely able to thrive and remain dominant in the years to come.

Prudent long-term holdings

Many of these high-quality companies are in the technology sector. Investors can consider the Invesco QQQ Trust, which provides diversified exposure to the 100 largest non-financial innovative companies. These include leaders in software, hardware, e-commerce, social media, biotechnology and other areas. As at end-December 2023, the Big Tech companies have a weightage of 31.53 per cent in the QQQ exchange-traded fund (ETF).

Another consideration would be Invesco Nasdaq Internet ETF, which provides a greater focus on the software aspect of the technology sector. At end-2023, Big Tech companies (excluding Apple) have a weightage of 31.66 per cent in the PNQI ETF.

High-quality companies can also be found in other sectors as well. We think investing in high-quality companies is a prudent long-term strategy that puts you in a far better position than chasing short-term market movements.

A diversified way to get exposure to high-quality companies is via the JPMorgan US Quality Factor ETF, which targets the highest-quality businesses with high profit margins and low debt levels. With an expense ratio of just 0.12 per cent, it is also one of the most cost-effective ETF amongst its peers.

The writer is a research analyst of the research and portfolio management team at FSMOne.com