Head into the cloud

23 August 2019

When assessing companies for growth, there are a number of common characteristics. And when it comes to IT, it is critical to ensure that potential for future growth is strong and enduring. The business must be one where the total addressable market is growing and large, that is, where the gross sales or revenue are growing faster than GDP. This is commonly referred to as a tailwind. 

Complementing that growth potential is economic leverage, with the business needing to be able to grow its earnings faster than revenue, indicating efficiency increases and therefore increased profits. 

Once the characteristics have been assessed other factors – such as the sustainability of the business offering over a three to five-year period, shareholder alignment (ideally controlled by company management), and customer perception of the brand’s product or service offering – need to come together in order to fully formulate a considered evaluation of a company and its investment potential.

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Economic instability both here and overseas is evidently having a detrimental impact on equity markets. A prolonging of the current trade impasse between China and the US looks likely to extend the status quo of sub-par economic growth and record low interest rates for the medium-term.

The key risk in this outlook is that sub-par growth actually turns into negative growth as policy missteps continue to escalate. However, notwithstanding these factors, this environment actually favours growth equities.

Low interest rates mean investors are attracted to, and eventually are prepared to pay more for, scarce growth assets in what has become a low-growth world. 

Regardless of the prevailing market noise, the key is to look for the aforementioned strong investment fundamentals to drive returns in the months and years ahead. That is, assets that can grow much faster than the economy and that can give returns much better than the economy. 

So-called ‘S-curves’ are also becoming more apparent in assessing growth stocks. S-curves are characterised by an ability to identify additional growth in an environment where there’s not a lot of overall growth. 

The best recent example of this is the trajectory of Apple’s domination of the smartphone market. It went from a 10 per cent share of the overall mobile phone market to a 75 per cent share in just six years. During this period, Apple’s stock increased seven times in value and drove competitors out of business in the process.


Software as a service (SaaS) or cloud computing is shaping up as the next fundamental S-curve and we would expect it to quickly move from a 10 per cent share of all enterprise computing spend today, to around a 40 to 50 per cent share over the next 10 years. 

IT expenditure – which grows between one to two per cent annually – is split between four key pillars: hardware, software, IT services and data centres. The adoption of cloud computing makes redundant the need for these pillars independently, with cost savings redirected into the one-stop-shop of the cloud. Companies don’t need to buy as much IT support, for example, as much of the software support previously provided by people is now automatically updated in the cloud. 

Microsoft is the obvious example of this working in practice, where people have moved from the purchasing of the Microsoft Office suite every few years to a subscription service with Microsoft 365 where they pay on a per annum basis. 

This is happening in most parts of the software ecosystem with different companies dominating different verticals. The effect of this will be a new wave of high growth software companies that will dominate the market, and there are no better examples at the moment than Adobe (media suite), Salesforce (CRM), and Atlassian (software developers). 

But while these stocks are highly valued, as investors can see the growth potential, they are still not valued correctly because of particular cashflow characteristics – this will correct itself as they move up the S-curve.  


Artificial intelligence (AI) is another theme within the tech space that’s likely to dominate over the coming years. 

The structural trend towards companies investing in AI will drive structural earnings growth for key beneficiaries and ultimately, result in positive investment returns regardless of what the market cycle brings in the short term. Notably, it is virtually impossible to find beneficiaries of this theme if only investing in the Australian market. 

At a basic level, AI is simply taking volumes of unstructured data and plugging it through a ‘big computer’ to give the user a predictive outcome that enhances their experience. The simplest forms today include the dynamic newsfeed on a Facebook profile, predictive shopping results on Amazon, or Google Maps highlighting the time your daily trip to work will take, before you asked for it. 

Ultimately in its full form, AI is likely to penetrate all businesses globally, and provide advertisers, consumer product companies and even industrial companies with better outcomes and insights for the same dollars spent.  

There are two primary facilitators of AI – connectivity and data. That is, companies that provide the technological infrastructure to connect with, receive and compute all the volumes of data in real time, and data companies that own the proprietary data sets that fuel AI to provide the required corporate insights. 

Connectivity between devices (including phones, homes, cars, industrial equipment, and health devices, to name just a few) and the network (cloud) is growing at an exponential rate. Data generated by all these connected devices can now be analysed and interpreted in real time by emerging AI applications. Memory, cloud and internet companies will all be the beneficiaries of this trend. 

The second key component of building AI is data. Data is the fuel that drives the predictive outcomes and consequently we see any company that owns a large dataset as likely to be more valuable in an AI world. Clearly the key internet players – in Google, Amazon and Facebook – are in the box seat, but many other companies possess datasets that cannot be replicated by the internet giants. 

Credit bureaus are one such example. Credit reporting agencies own unique datasets and products, and credit agencies have been collecting data on individuals since before the internet existed. 

Today, their datasets extend to other verticals including employment, healthcare, insurance, and utilities, with a view to building the dataset, technology and platform once and selling it many times over to corporates across multiple industries.


With this in mind, the development and adoption of 5G infrastructure is also driving the shift in tech investing. With linkage between the progress of 5G to data integrity and security, the technology remains an intriguing investment theme.  

As 5G will enable a wide number of technological advancements in areas such as progressive health tech, autonomous vehicles, smart phones, smart cities, and virtual and augmented reality, the integrity of the infrastructure is paramount. 

For investors, this infrastructure will take some time to develop, and establish principles of how data integrity is ensured. The technology has a long runway of growth ahead of it and is currently almost non-existent in connections and mobile devices in terms of penetration. 

The perception that cybersecurity requirements are already challenging for companies will be further tested with 5G. But, these increased demands will, in turn, have a positive flow on effect for cloud computing providers tasked with ensuring data security. 


So, despite economic conditions here and abroad hampering equities growth, there are nevertheless certain segments of the tech sector are well positioned to weather this instability – particularly when it comes to global opportunities. Investors should shift their focus to these growth stocks with structural tailwinds. While all companies lay claim to growth, only a very small portion grow independently of the broader economic cycle.  

Nick Griffin is chief investment officer at Munro Partners.

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