A review of Forbes 20th rendition of the Global 2000 list, made up of large public companies with a combined market capitalization of $76.7 trillion and combined profit of $5 trillion, showed signs that large tech firms on the list that adopted blockchain technology could be facing a profitability reckoning in a growing inflationary environment.
As of the latest trailing four-quarters available and current market values for Global 2000-ranked firms in FactSet as of April 22, 2022, information technology (IT) software and services stocks held 10.5% of the total market cap for the 2,000 ranked firms, but only 5.6% of global profits. That’s compared to major bank stocks which held 4.3% of total market value and 9.1% of global profits.
By measuring the theoretical market value which these two sectors could have based on their share of Global 2,000 profits, we learned that IT Software stocks are overvalued by as much as 88% while bank stocks are undervalued by 38%. Thus, had tech firms had 5.6% of Global 2,000 market valuation (equal to their share of profits), their market value would have been $4.3 trillion, not $8 trillion.
Blockchain Shine Wearing Off?
Over the past four years, Forbes has recognized more than 100 firms for their robust blockchain initiatives in what we call the Forbes Blockchain 50 list. In our valuation exercise, the Blockchain 50 accolade acts as a proxy of a firm’s proclivity to adopt potentially disruptive technologies fastest. Not surprisingly, the top five IT Software firms by market capitalization in the Global 2000 list received a Blockchain 50 recognition: Microsoft (MSFT #12 in the Global 2000 list), Alphabet (GOOGL #11), Meta (FB, #34), Tencent (Tencent, #28), and Oracle (ORCL, #114).
Conversely, only three of the five largest banks and diversified financial services firms attained the Forbes Blockchain 50 distinction. The majority of these firms’ had impressive double-digit profitability, but that wasn’t enough to give investors a robust stock price appreciation.
The largest traditional finance firm and that also ranked first on this year’s Global 2000 list, Berkshire Hathaway (BRK.B,), recently restated its opposition to digital assets - investments built with blockchain technology - during its annual investor gathering. The second-largest, JPMorgan Chase (JPM, #4 on the list) meanwhile has had a love-hate relationship with cryptocurrencies but followed the pragmatic approach to develop blockchain projects such as ethereum-based Quorum and blockchain subsidiary, Onyx. But a growing number of banks of all sizes - 35 shown in a recent Wall Street Journal full page ad - adopted in 2021 and 2022 the ability to offer bitcoin investing to clients through the services of technology firms like NYDIG and Paxos.
Time For A Reset?
Investors forgive tech firms’ lack of profitability for lengthy periods, but a profitability-based valuation may boomerang and cause bull-cycle darlings at greater risk than firms with strong profitability. An important secondary reason for tech stock excessive appreciation may be related to how passive investing follows rigid allocation rules that could give tech stocks a higher share than they deserve from a profitability perspective.
What about banks’ blues? Is this a buying opportunity? It’s undeniable that bank balance sheets will take a hit as nonperforming loans grow from 1.6% in 2020 - they reached 7.5% in 2010 following the financial crisis. But it is also true that much of bank balance sheets are cleaner. Today there are only vestiges of Wall Street toxicity due to much stricter regulations on things like risk-based capitalization requirements. Perhaps more importantly, banks are likely to improve their financial spread in coming years. That is, interest rate increases from the Fed will likely translate to more bank profit because these will hike lending rates faster than their borrowing costs. And, banks will likely pass on to depositors higher yields very gradually, these asymmetric measures (hike rates right away, pass on higher rates to depositors gradually) result in higher profitability.
