Right here on the JSE you’ll find a couple of technology companies that are growing in the same verticals that get people excited in the US: big data, payments, software and cloud. There are a few local companies that are getting a slice of this action.
The US tech sector had the rollercoaster ride of a lifetime over the pandemic, with many shares doubling and tripling in value (or more) and then giving up most of the gains in 2022. There’s no force stronger than macroeconomics, with share prices moving dramatically in response to prevailing interest rates.
If nothing else, investors would do well to carry that lesson from the pandemic. The best way to learn about the “time value of money” is to watch your money halve in value.
Local tech companies may not have had quite the ride of their US counterparts, but there were still major movements. With recent earnings updates from Capital Appreciation and PBT Group, the share prices reflect the market’s view after digesting these numbers. This makes it a good time to reflect on the performance.
Capital Appreciation has had a year of capital depreciation, with a 21% drop in the share price in 2022. Still, the company is now trading at about double its pre-pandemic levels, so the through-the-cycle view is still strong.
Now changing hands at nearly R10, that’s a five times return during an intensely difficult time in the world
This performance is dwarfed by PBT Group, with a gain of nearly 29% this year. That’s an incredible outcome when viewed against competitors and the broader market.
The real shock is when you draw a chart that starts before the pandemic, with the share price trading at about R2 at the beginning of 2020. Now changing hands at nearly R10, that’s a five times return during an intensely difficult time in the world.
Both companies would’ve been great investments over this period, reminding us that local can be lekker. Over a similar period, the Nasdaq-100 has returned about 36%, admittedly in dollars. With the rand trading at about R14.30 at the start of 2020 and now at R17.50, the return to South African shareholders would be 66%. Even with the currency depreciation, local “small tech” has beaten global “big tech” over this period.
There are a few lessons here, one being that choosing winners among small caps is a lucrative game in the market. If you can find yourself a gem that most people don’t know about, or that the market has clearly mispriced, the rewards can be substantial. It’s a risky approach, though, as small companies sometimes fade away into nothingness. When taking punts on single stocks (especially small caps), it’s possible to lose literally all your money. As Steinhoff once taught us, that can apply to large caps as well.
The risks are compounded when investing in offshore small caps, as South African investors don’t have the benefit of ground-level knowledge on these companies. This is where international research offerings become helpful, written by in-country specialists. They are unfortunately beyond the reach of most retail investors, as is the ability to execute trades on small caps in obscure markets.
This means that for many small-cap enthusiasts, opportunities need to be uncovered in the local market. For this reason, there is great frustration among investors with the lack of choice on the JSE and the trend of delistings of small- and mid-cap companies trading at stubbornly low valuations.
Speaking of valuations, that’s another area where we can learn something from this outperformance of the two local technology companies. Overpaying for growth simply doesn’t work unless you’re planning to trade a momentum strategy (that is, get out in time) rather than the approach of buy and hold at the right price. Trading strategies and investing strategies are not the same.
The main lesson is that a company such as PBT Group benefits just as much from cloud deployment and big data as Accenture does on the global stage, yet it traded at a much less demanding valuation multiple. This created a recipe for outperformance.
Eventually, the market catches on to the story and the valuation multiple increases to a level where the share price can no longer be considered cheap. To make this assessment, look at how the multiple has changed over time, especially through different macroeconomic cycles. When strong returns have been driven by earnings (that is, steady multiples), there might be room for more excitement in the share price.
When returns are mainly due to a higher multiple, there’s a real risk of being too late and getting burnt.
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