March Update, 2018

When one thinks of great empires, one can look back at the great Russian, Mongolian and British empires as such entities. They ruled the world at their respective times, had overwhelming power and control over their regimes, and controlled a large portion of the world (anywhere from 15% to 23.84% of the world’s land area). When we think about modern empires today, we think of the companies that operate in millions of square feet, as opposed to square kilometres, which pales in comparison to the physical scope of the empires of yesteryear.

However, in a sense, these historical empires garnered far less power than the technology companies of today. As the great empires of the past grew, they were forced to deal with war, rebellion, disease, famine and a swath of other problems ultimately leading to their collapse – many of these problems can be (simply) attributed to the inability to deal with scale. The technology empires of today are not built on land and armies, but on lines of code. In the empires of today, information is king and information is best collected and applied through mass scale – the bigger they grow, the stronger, smarter, and more prolific they become. These empires are here to stay but thankfully, you are profiting from their domination.

Recently, several companies you own have reported rates of revenue growth that were astonishing. Booking.com (formerly Priceline.com), Amazon and Google are just a few examples. Booking.com posted double digit growth for 44 of the last 47 quarters, averaging a growth rate of 24.6%! Amazons organic retail revenue growth was 24%, matching the last 20 straight quarters. Google had 21% advertising revenue growth last quarter. Google has done this for the past 32 quarters. The quanta of companies that have ever done this- much less at this size- are like unicorns in fields of golden lilies.

These are the largest companies in the world. They aren’t growing off a small base – their revenues are booming and their profits are increasing at an incredibly rapid and expanding pace. Seldom in history have a few companies grown at this pace for such an extended period of time and amassed so much wealth and market share for their owners. It took Warren Buffet 50 years to grow Berkshire Hathaway to be worth $500 million. Facebook did it in 13 years.

Perhaps more ominously, seldom in history has such great power and scale been concentrated in such few hands, and with such significant global impact and reach.

What happens next? Can profits at these companies continue rising to the skies? Are the valuations expensive? If they are so profitable, when are they going to pay me dividends? How big of a worry is government regulation?

There are a number of themes that we think will keep these companies at the forefront of profit growth into the future. Internet communication demand trends remain consistent and there is little reason to see them slowing in the next two or three years. It seems unlikely that we are going back to our old ways. Customers have increasingly become accustomed to getting things faster, and now want more speed and efficiency at lower costs.

Politicians have recently exercised concerns about power and potential abuse by these titans. Progress will not be easily denied by politics for long. The services supplied by these behemoths make our lives so much easier today. These companies are huge because people choose to make them so. They vote billions of times per day with the use of their usually “free services”. Consolidation and concentration in the information world remains an ongoing trend and increasingly, it is a winner-take- all type world. Again we – BILLIONS of us – pick the winners and we reward simplicity and efficiency (‘someone get me what I want fast’!).

These companies are generating so much cash that they are beginning to purchase businesses in other areas of the economy. Amazon buying Whole Foods was a shot across the bow, not just at other Grocers and Mall owners globally, but toward anyone in business. It is sending the message that “you had better be on your toes because we understand very well what the customer wants and we will build it.”

These companies are generating such large profits in excess of their internal needs that they are increasingly paying dividends that are growing rapidly and returning shareholder money via stock buybacks. Combined, the companies you own will return $120 billion dollars to shareholders this year even while solidifying their future by investing $80 billion this year in research and development. For those of you who are wondering what kinds of returns that investment is likely to earn – mark it down to a (very conservatively) cool $11.4 billion in new earnings power on average. Putting it in a different way – if Apple invests $1, they tend to earn $1.26, and our companies on average earn 14%. Personally, I like dividends too but please, if you are Apple or any other of these companies, please reinvest as much as possible internally at your rates of return before you make me give some of my money to the government.

The sheer size of these companies is manifest in their global reach. On average, these companies generate greater than 40% of their revenues on an international basis. If you want to look for international diversification in an increasingly correlated world, why not cut the risk by just buying the best companies in the world?! We tend to subscribe to the Keep It Simple Stupid principle (KISS). It’s a good strategy – it seems elections are also won this way.

The incredible profitability, scale, information and influence these companies have on society are also increasingly attracting the attention of governments both globally and in the United States. This is a risk that we have talked about in the past and increasingly, is a risk you’re likely seeing more of in the news these days.

In China, the government has taken the approach of working closely with their technology leaders (think of companies like Alibaba) and using the information gathering powers of these companies to track the behaviors, movements and thoughts of their population – a chilling thought that makes most in a democratic society shiver. In America, the government has the power to collect such data (think of Edward Snowden) and is expected to police itself through the rule of law. It would seem reasonable to expect these companies will have increased regulation to ensure that personal privacy is respected in the future.

The million-dollar question is what impact will regulation have on these companies. In many respects, it is an unknowable answer until the regulations are known. What we do know is that the types of remedies presently being discussed are likely to further entrench the positions of power held by these companies by increasing the costs that any newcomer would bear to compete.

Interestingly, these companies are increasingly investing their enormous profits and diversifying away from their legacy businesses and hence reducing some of the risks to the future. Amazon has morphed from being a bookseller to become one of the largest suppliers of computer power and security to other companies, a producer of movies and an owner of a large grocer. Google is launching what will soon be the most advanced autonomous driving fleets of cars in the world and has a large healthcare division, working on projects such as contact lens that allow people with diabetes to check their glucose levels in a nonintrusive manner. One thing is constant today and that is change and the pace that these companies change and grow profitably is unmatched in history.

That is what really brings the value and earnings power of these companies into sharp focus: the power of all knowledge. Can any government successfully combat that? It is an existential question for business and government, and one whose answer is increasingly being debated as we hurtle toward an era where voters and investors listen, learn, see and use information through the companies that you own.

The next months are sure to highlight the enormous power of these companies as politicians fight for headlines in the rush to write laws that regulate speech and privacy. It must be remembered that it is the politician who best practices the art of attack ads and misdirection. They will have to grapple with issues where no easy answers exist and heavy-handed outcomes threaten not just consumer privacy, but also what they like and use. It also could threaten the industry that has provided the largest growth in jobs, income, taxes and innovation. We do not know the outcome of this battle. We only know that they are the fastest growing, most profitable businesses in the world that despite what may come, will likely still provide for very attractive long-term returns. In fact, the threats and cost of regulation are likely to entrench these businesses further as potential new entrants will also have to bear the burden of government regulation.

-John