• Big tech has been on a roll this year
  • The Nasdaq is up over 50%
  • Small tech offers much better value

Leading the global stock markets all year, US big tech is on a roll so far this month. At the time of writing – Friday 15 December – the Nasdaq index is up over 50% year-to-date. It is now closing in on the all-time high set in late 2021.

Should a breakout ensue, then momentum could carry the Nasdaq even farther heading into the new year. Meanwhile, the broader stock market continues to struggle and, thus, the gap between the two continues to grow. The US Dow Jones Industrial Average is up only 12% year-to-date. The UK FTSE 100 index is nearly unchanged, with positive returns only due to dividends.

It is rare for such a small number of large companies to outperform the broader market for such a sustained period of time. There was one such period in the US back in the 1960s, when the so-called “Nifty Fifty” remained market leaders for years. But they were 50. Today, the Nasdaq leaders are fewer than ten and include: Apple, Microsoft, Amazon, Nvidia, Alphabet (Google), Meta (Facebook) and Tesla.

The market is sending a clear message: tech is where it’s at. And given that the vast bulk of these companies’ valuations are based on so-called “intangibles”, rather than current profit (earnings) or cash generation (free cash flow), tech is where it is going to be for a long time yet.

Perhaps. I’m somewhat sceptical of intangible valuation techniques. They rest on huge, questionable assumptions about the future. They may be proven correct in time, but it has got to the point where big tech has become the “big expensive” way to invest in the tech sector.

This is why it has become so important to start looking not at the big boulders of tech but at the gems hidden between the rocks: the smaller companies developing next-generation technologies. Much of these might one day be absorbed by big tech firms, but at significantly higher valuations.

It is commonplace in corporate finance that, with the notable exception of distressed firms, when large firms acquire smaller ones, they tend to do so at generous valuation premiums. It holds across all industries and across time. Tech, in the future, should be no exception.

Hence, given how enormously expensive the big-tech boulders have become, what is needed is a way to find the hidden gems. Fortunately, my colleague Sam Volkering is a well-seasoned specialist in this area. He has recently launched a dedicated Substack column, AI Collision, which focuses on arguably the highest-profile tech topic of the year and quite possibly next: artificial intelligence (AI). I strongly recommend you take a look.

If you like what you see, sign up to follow. It’s entirely free of charge and is as good a place as any to begin your search for the AI gems between the boulders.

Until next time,

John Butler
Investment Director, Fortune & Freedom