Technology companies have a lot of cash on hand, but what does that mean in terms of their role in investors’ portfolios?
When major technology companies reported their earnings this summer, a common trend was the large amounts of cash many have on hand. Apple, for instance, reported that it now has $210 billion in cash. To put that in perspective, that’s enough to purchase every professional sports franchise in North America, except for the bottom four NHL teams.
The spending power these companies have makes the tech industry both interesting and challenging for advisors looking to incorporate these stocks in portfolios. Joseph Alfie, an investment advisor at HollisWealth, a division of Industrial Alliance Securities, sees that cash as a result of three factors.
“First, given today’s interest rate environment, it is a great strategy to raise debt in order to deduct the interest at the end of the fiscal year,” he says. “This allows companies to sit on a lot of cash and have flexibility to do as they please. If we see rates going up, it’s probable that these companies’ cash positions will start dwindling down.
“Second, in regard to taxation,” he continues, “some of the tech companies have advanced tax structures and earn a lot of their income overseas. In the United States, foreign-source income earned by US companies is only taxed once repatriated back to the US. The increase in cash position is likely to continue unless we see a tax change.
“Third, companies such Apple, Google, Amazon and Microsoft have reinvested in their business tremendously over the last 10 years, which led to them being able to pile a lot of cash. In these current uncertain market conditions where valuations are high, they are comfortable sitting on a tremendous amount of cash in order to be prepared for the next pullback, whether it means purchasing more stock or for mergers and acquisitions.”
Adam Pulla, financial advisor and partner at Northstone Wealth and Estate, stresses that the level of cash isn’t the only thing investors should be looking at.
“How the company uses the cash is more important than how much cash a company has,” he says. “While many of the large technology firms have been cash-heavy for quite some time, not just quarterly, sentiment for technology stocks has changed rapidly this year. Technology companies with high cash but lower growth will likely give the cash back to investors in the form of dividends, whereas companies that continue to see growth opportunities will not need to return that cash to investors.”
Tech companies have been spending on things such as adding hardware suppliers, further developing their own services, and real estate for office space, warehouses, and data centres. Yet they still have strong cash positions. Alfie believes that may have something to do with the timing of the current market cycle.
“I think they are probably waiting for a pullback,” he says. “They have had tremendous growth over the last five years, so it might be a defensive strategy. They might be a little concerned about where the market is at – maybe in a vulnerable position.”
Such a defensive strategy would allow tech companies to weather some of the headwinds they’ve been experiencing. “Privacy concerns, potential anti-trust legislation and thoughts about some technology firms being too big has been concerning for not just governments, but also the general public,” Pulla says, also pointing to ongoing trade disputes as an issue that could add to those headwinds.
Despite those fears, Alfie remains bullish on tech companies. “Cash is king; they are preparing themselves for the next position in the market,” he says. “If there is a recession, they are going to have plenty of cash to buy back their stock, so they are borrowing to invest at all-time lows. To me, it is a great business decision.”
If the trade disputes continue, Alfie believes the tech sector will be one of the most volatile, yet he also feels it will offer the most opportunity when things settle down.
“Most of the tech companies sitting on large piles of cash are great businesses – leaders in their industry and brand names that people want to own,” he says. “The fact that they have cash and are still able to grow reassures me. I feel very comfortable investing in these companies. I believe having cash on the balance sheet and being in a growth industry offers the best of both worlds – growth and a little safety blanket.”
Even with the potential volatility and headwinds, Alfie feels it’s important to find ways to get tech companies in his clients’ portfolios.
“I think advisors should keep buying big names, especially the ones with recurring revenue models,” he says. “But I think now more than ever, given the valuations, the key is to buy strategically. If you were thinking of allocating 10% of a client’s portfolio in tech, then allocate 5% and, if necessary, dollar cost average any future purchase over time.”
