Big Tech and Regulation: What to Know as an Investor
Updated: Jul 25, 2021
How will government regulation affect our investments in big tech companies? If you follow political headlines recently, this question may be on your mind. There are more and more actions being taken by governments globally to try to address several issues with big tech companies. In this post we will discuss what changes we may expect and how these changes may affect us as investors.
What’s not to like?
Of the largest 10 US companies in the stock market by market cap, 5 are technology companies or digital businesses. FAANG (Facebook, Apple, Amazon, Netflix, and Google) have become the providers of essential services for many of us and a core part of the markets. Consider, that these companies together have a market value that exceeds $7 Trillion and since 2013 has rewarded investors with dramatic outperformance compared to the overall market.
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However, even though investors have pocketed some good returns, the size and influence of these companies brings high levels of scrutiny that may become roadblocks to future growth. Here are some of the criticisms that are leading regulators to take action against Big Tech:
Regulation of Big Tech isn’t new, it’s just that global trends are starting to be noticed at home. The European Union has been aggressive in implementing legislation and fines aimed at enforcing data protection and limiting anti-competitive business practices. Recently there have been several actions taken in the US to address the influence of Big Tech on competition. Last year, the Justice Department filed an antitrust lawsuit against Google and the FTC sued Facebook over its acquisitions of WhatsApp and Instagram. At the state level, many states are joining these efforts or introducing their own legislation.
Privacy and data transparency have become important issues and many governments are trying to figure out how to implement protections. Since there are benefits to collecting data, this legislation will most likely be complicated and slow.
This issue is a bit divisive. On one hand there are issues with the amount of negative content and the effects of it on our well-being. There is well-deserved criticism of the rampant hate speech, bullying, and false information that is being distributed online. However, there is also criticism of censorship and accusations of a bias toward certain views.
There are also a few other recent issues that have caught regulator's attention such as the ability for investors to organize and take action to influence markets through “Meme stocks”.
What to expect
While the issues above are very real, there is not a simple solution. Actions that have been introduced against Big Tech face an uphill battle. Last month the cases against Facebook mentioned above were dismissed by the court because the case did not have sufficient evidence to support it. Many say that the case against Google faces similar challenges.
With regard to privacy, many companies are taking actions to solve the problems themselves and actually bolster their own value in the process. A great example is the recent change that Apple made to its operating systems that limits companies’ access to IDFA (Identifier for advertisers). Tracy Li, a financial analyst with Capital Group, gave some insight into how Big Tech may actually benefit from controls on privacy: “I believe that concerns related to privacy or content may actually strengthen, rather than weaken, the moats of the largest platforms. These companies often boast well-established protocols and have more resources to tackle privacy and legal matters.”
Content issues will likely be dealt with in a reform to current regulation. This may lead to increased legal costs for online companies which will most likely have a minor effect on the largest companies but possibly create a barrier to entry for smaller competitors.
What about the stock market?
The consensus is that regulatory challenges will not have a major impact on investors in Big Tech. This is good news for most of us. Here are some important points to consider as an investor:
Regulation is priced in
Again, these challenges are not new and much of the risk is reflected in valuations of these companies. If we look at current valuations of Big Tech, they are not overly excessive. Especially as the market has broadened over the first half of this year. Consider the chart below. If we examine valuations of the two companies under the most scrutiny right now, Facebook and Alphabet, their P/E ratios are quite a bit lower than others like Netflix and Amazon.
We can learn from the past
A helpful comparison is to look at the effects of Dodd-Frank regulation after The Great Financial Crisis. While this regulation created an expensive environment for banks to do business, the biggest banks survived and actually thrived over the decade following the introduction of the law. Part of the reason they did well, is they started this period with low valuations. As mentioned above, tech valuations may offer a long runway for future growth.
We shouldn’t worry about breakups
It is unlikely that the government will intervene and breakup these companies. However, if that were to happen, there is an argument that the parts may be greater than the whole. For example, WhatsApp, Instagram and Facebook Messenger are all part of Facebook. One could make the case that if any one of these companies were monetized individually, they would be a good investment. The same could be said for YouTube and Alphabet’s other platforms.
As an investor, it is always important to focus on what we can control. We can’t foresee the results of any regulation against Big Tech but we can be smart about how we fit these companies into our total portfolio. Naturally, because of their size in the market we will have a lot of exposure to tech through most U.S. Large Stock funds. With this in mind, it is important to diversify and make sure that you include exposure to smaller companies, international companies, etc.
So far this year, we have seen performance broaden out to other areas of the market away from technology. This has been a welcome change that has allowed valuations to moderate. It has also set the stage for tech to continue a path of growth amid rising challenges to company profits.
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Centered Financial, LLC is a registered investment adviser offering advisory services in the State of California, Utah, Texas and in other jurisdictions where exempted. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. There is no assurance that the techniques, strategies, or investments discussed are suitable for all investors or will yield positive outcomes. To determine which strategies or investment(s) may be appropriate for you, consult your financial adviser prior to investing. Any discussion of strategies related to tax or legal planning is general and is not intended as tax or legal advice. Please consult appropriate tax and legal professionals for recommendations pertaining to your specific situation.
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