Tech-Driven Value: How Technology Companies Fit in Today’s Investment Strategy
Why the old boundaries between technology and traditional sectors no longer hold: a value investor's opportunity
Once, technology and traditional industries seemed worlds apart. Today, that line is almost invisible. From retail to finance, technology has woven itself into the very core of how companies operate. And for value investors, it’s time to rethink what tech really means.
Historically, value investors have often shied away from technology companies, viewing them as too volatile and fast-changing to provide predictable long-term returns. However, this cautious stance may no longer fully capture the transformation happening across sectors. Technology is no longer confined to a single sector, it has woven itself into the very fabric of how most businesses operate, challenging the old paradigms of value investing and reshaping the investment landscape.
How GICS Classifies Companies and Industries
The Global Industry Classification Standard (GICS) is a system used to classify companies and securities into sectors and industries. It was developed by MSCI and S&P Global in 1999 to provide a consistent, globally recognized framework for categorizing publicly traded companies based on their principal business activities. GICS divides the market into sectors, which are further subdivided into industry groups, industries, and sub-industries.
This hierarchical structure allows investors to analyze and compare companies within and across industries.
The evolution of global industry sectors is dynamic, continually adapting to reflect the changing market landscape. As a result, MSCI and S&P Global have announced in March 2023 another update to the GICS framework, including the reclassification of various industries and sub-industries to better align with current market trends and business activities.
GICS and the Structure of the Information Technology Sector
As of the writing of this article, the Information Technology sector within the GICS framework encompasses companies primarily involved in the development, manufacturing, and distribution of technology-based products and services. This sector is divided into three main industry groups: Software & Services, which includes businesses specializing in software development, IT consulting, and data processing; Technology Hardware & Equipment, which covers companies producing computers, peripherals, smartphones, and electronic equipment; and Semiconductors & Semiconductor Equipment, comprising businesses involved in designing and manufacturing chips and related components used in electronics. The sector drives innovation across industries through advancements in computing, artificial intelligence, cloud technology, and communications, playing a central role in shaping modern economies.
Why Traditional Sectors Can’t Escape Technology
As we witness the evolving market landscape, one thing is clear: traditional boundaries between industries are becoming increasingly blurred. Classification systems like GICS continue to label businesses based on established categories, but the reality on the ground is more nuanced. Companies across sectors are being transformed by technology, even in industries where tech wasn’t historically a key driver. For instance, Tesla, though classified under the automotive sector, is widely regarded as a technology pioneer. Tesla’s competitive advantage lies in its use of advanced software for autonomous driving, data collection, and vehicle optimization.
The same can be said for energy, a sector once considered slow to change. Solar companies now use sophisticated software to manage energy grids, while oil and gas giants rely on data analytics and artificial intelligence to optimize extraction and refining processes. Similarly, retailers like Amazon and Shopify may be considered technology companies because they’ve integrated complex logistics, customer acquisition, and distribution models into their operations. However, traditional retailers like Walmart and Costco have also embraced technology in response, investing in e-commerce, data analytics, and inventory management to stay competitive in an increasingly digital marketplace.
In financial services, the situation is no different. Companies like Visa and Mastercard are payment processors, but they rely on massive technology infrastructure to operate. Fintech innovations, mobile payments, and even blockchain are revolutionizing the way transactions occur. Banks, payment processors, and investment companies are no longer purely financial institutions but rather tech-enabled entities driven by data and digital platforms.
When we think about what truly drives the revenue of companies like Google or Facebook, we don’t necessarily see a pure technology operation at work in their primary business models. Google’s search engine and Facebook’s social media platforms are revolutionary products of technological advancement, but their revenues and cash flows are predominantly generated by digital advertising. These companies have successfully monetized their platforms by leveraging user data and targeting advertisements, a model made possible by technological sophistication, but at its heart, still rooted in advertising. In fact, one could argue that both companies are, in essence, advertising companies fueled by data and algorithms, rather than being tech-centric in the traditional sense. The infrastructure and user interface are undeniably technological, but their core cash-generating machine is marketing.
This leads to a broader observation: technology is now woven into the very fabric of nearly every business, regardless of the sector. Whether it’s retail, financial services, healthcare, advertising, or manufacturing, companies are leveraging technology to optimize operations, reach consumers, and remain competitive in an ever-evolving marketplace.
Should Technology Even Be a Sector in the First Place?
Should we continue to classify businesses into rigid sectors, or should we acknowledge that the very nature of business is becoming technological? Today, technology is more than just a sector; it is the backbone of nearly all industries. Automation, artificial intelligence, cloud computing, and data analytics are no longer confined to specific tech companies, they are pervasive, driving growth, innovation, and disruption across all sectors. Every company, in one way or another, is becoming a tech company, or at least one heavily influenced by technology.
The continued use of a distinct Information Technology sector may serve as a convenient catch-all for companies with innovative business models, but does this classification truly reflect the nature of today’s markets, or is it a dated framework that no longer aligns with how businesses operate? I’ll leave the reader to ponder this rhetorical question as we navigate the shifting landscape of a technology-driven economy.
The 2018 GICS Reclassification: Moving Beyond Information Technology
In 2018, the GICS underwent a significant reclassification to better reflect the evolving landscape of modern industries. As technology became increasingly embedded in various sectors, the traditional boundaries between industries began to blur. This prompted MSCI and S&P Global to update the GICS framework, specifically affecting the Information Technology and Telecommunication Services sectors.
The most notable change was the creation of the new Communication Services sector, which absorbed companies that were previously classified under Information Technology and Consumer Discretionary. This move aimed to acknowledge the growing importance of digital media, entertainment, and communication platforms, which were increasingly relying on technological infrastructure but were not, at their core, technology companies. Several prominent companies were reclassified away from Information Technology during this restructuring:
Google (Alphabet): Previously part of the Information Technology sector, Google was reclassified into the Communication Services sector, under the Interactive Media & Services industry group. This shift reflected the company’s primary revenue driver, digital advertising, and its role as a media and content provider through platforms like Google Search, YouTube, and Google Ads. Though Google is a tech-driven business, its operations are more aligned with the media and communication space.
Facebook (Meta): Facebook, another company reliant on technology, was also moved from Information Technology to Communication Services under the same industry group. Facebook’s main business is providing social media and advertising services, and this reclassification better reflected its focus on connecting users and delivering digital advertising, which is central to its revenue.
Netflix: Although Netflix is often viewed as a tech company due to its streaming platform, it was reclassified under Communication Services, specifically in the Entertainment industry. The reclassification acknowledged that Netflix’s core business revolves around content production, media distribution, and entertainment, rather than being primarily a technology provider.
The 2018 GICS reclassification reflected the growing convergence of media, technology, and communication. Companies like Google, Facebook, and Netflix were seen as fundamentally media and advertising-driven rather than technology manufacturers or service providers. As these companies grew in influence and market share, their classification needed to evolve to accurately represent their business models. The new Communication Services sector was designed to capture the broader scope of content, social media, and digital platforms that rely on technology but are driven by consumer engagement and media distribution.
This reclassification helped clarify the distinction between companies that develop and sell technological products and services, such as Microsoft and Apple, and those that utilize technology as a tool to provide media, communication, and advertising, such as Google and Facebook. It acknowledged that while technology powers many modern businesses, it is not necessarily the defining characteristic of every company once labeled as tech.
Big Tech: Is It Time to Rethink the Term?
Despite the 2018 GICS reclassification, which appropriately moved companies like Google (Alphabet) and Facebook (Meta) from Information Technology to the Communication Services sector, market commentators and financial analysts continue to group these companies under the broad label of Big Tech. Historically, this group of companies was referred to as FAANG, an acronym coined by Jim Cramer of CNBC in 2013, which stood for Facebook, Amazon, Apple, Netflix, and Google. As the landscape evolved, the term Magnificent 7 (or Mag 7) emerged, coined by Bloomberg in 2023, reflecting the expanded dominance of Apple, Microsoft, Amazon, Google (Alphabet), Facebook (Meta), Tesla, and Nvidia.
The term Big Tech and, since 2023, the term Magnificent 7 are popular among market commentators for several reasons:
Market influence: These companies have outsized impacts on stock indices like the S&P 500 and Nasdaq 100, often driving much of the market’s performance. Their sheer size and market capitalization, combined with their global reach, make them central players in discussions about economic trends and market dynamics.
The Magnificent 7 have been the driving force behind S&P 500 earnings growth and share price returns over the past decade. For the past 3 years this is demonstrated in the excellent Guide to the Markets by J.P.Morgan Asset Management.
On the left, J.P.Morgan breaks out share price returns of the Mag 7 and the rest of the S&P 500: While the Mag 7 stocks contributed 63% of the positive performance in 2023, they also contributed 56% of the negative performance in 2022. On the right we can see their fundamental strength: The top shows that S&P 500 Earnings Per Share (EPS) growth in 2023 would have been negative without the Mag 7. The bottom shows that the Mag 7 have also been driving profit margin expansion since the second quarter of 2022, demonstrating operating leverage and the ability to improve operational efficiency. This followed periods of heavy investments in R&D and capital expenditure (CapEx) during 2022 and earlier years, as they swiftly responded to the COVID-19 pandemic and adapted to the post-pandemic economic landscape.
Innovation leadership: These companies are key innovators in fields like artificial intelligence, cloud computing, e-commerce, digital advertising, and electric vehicles. Their leadership in these areas often defines technological trends and disrupts traditional business models across industries.
Global economic power: Big Tech companies are not just leaders in their sectors but also in shaping the global economy. Their influence extends beyond technology to impact other industries, including retail, entertainment, and finance.
As companies diversify and technology becomes ubiquitous across all sectors, the distinction between tech and non-tech becomes increasingly blurred. Should we retire the broad-brush term Big Tech in favor of more specific classifications that reflect the core business activities of these companies?
While the term Big Tech may still resonate with the general public due to its simplicity and historical context, it may no longer fully capture the nuanced roles these companies play in the modern economy. It’s worth considering whether the nomenclature should evolve, just as the businesses themselves have, to better reflect their multifaceted operations.
Technology and Value Investing: A Shift in Perspective
Historically, value investors steered clear of the tech sector because of its rapid pace of change. Technologies that seem revolutionary today often become obsolete within a few years, making it as unpredictable as a fast-changing fashion trend. For long-term investors aiming to project a company’s cash flow two decades into the future, this uncertainty made tech feel uninvestable.
As a seasoned and thoughtful investor I respect has noted, “Technology is the forbidden fruit for value investors”. The classical approach to value investing focuses on companies that operate in stable, slow-changing industries, where future outcomes can be forecasted with relative certainty. Sectors like utilities, supermarkets, retail, and credit cards were long considered the playgrounds of value investors because they appeared resistant to rapid change.
History has proven otherwise.
Newspapers, once a haven for conservative investors, have been largely decimated by the internet. TV networks now face fierce competition from YouTube, Netflix, and other digital content platforms, while supermarkets are grappling with the superior operational models of discounters and e-commerce giants. Even credit card companies, long considered untouchable, must now negotiate the shift to online and mobile payments.
This evolution underscores a central point: there are no industries immune to change. It strikes me as a far better policy to acknowledge the inevitability of change and account for it in capital allocation decisions, rather than pretending that some sectors will remain untouched for decades to come. Just as we’ve seen with industries once thought to be stable, every company must face the reality that technology is reshaping its landscape.
Embracing Technology While Staying True to Value Investing
For the modern value investor, this raises a question: Does embracing technology-powered companies mean straying from the principles of value investing? I don’t believe so. After all, traditional value investing rests on identifying companies with stable cash flows, strong competitive advantages, predictable long-term prospects, and buying them at attractive prices.
It’s critical to recognize that while technology companies may have once been considered high-risk, many have matured into businesses with strong, defensible moats, durable revenue streams and expanding profit margins. Companies like Apple, Microsoft, and Alphabet (Google) no longer represent speculative investments; they are cash-flow-rich enterprises with dominant market positions, substantial economic moats, and significant pricing power, traits that any value investor would seek.
Parallels Between Tech Companies Today and Traditional Value Investing
The key to integrating technology companies into a value investing approach lies in finding parallel characteristics between traditional value investments and today’s technology-driven companies:
Wide economic moats: Many of the world’s top tech companies have developed substantial barriers to entry. Consider Microsoft’s integration into enterprise software. The company controls critical parts of digital infrastructure, giving it the same kind of durable competitive advantages once associated with industries like utilities or railroads.
Recurring revenues: Subscription-based models, cloud services, and advertising platforms have provided tech-driven companies with predictable, recurring revenue streams. Much like Coca-Cola’s ability to generate consistent sales from its products, today’s business giants have found ways to lock in long-term revenue through services that are essential to consumers and businesses alike.
Cash generation: Companies like Apple are sitting on massive cash reserves thanks to their ability to generate huge profits from both hardware sales and services. This cash-generation capability mirrors the attractive features of traditional blue-chip companies like Johnson & Johnson or Procter & Gamble.
Management of capital: Good capital allocation is a hallmark of value investing. Technology-driven companies like Amazon and Meta (Facebook), despite periods of heavy reinvestment, have shown discipline in managing capital in ways that support long-term shareholder value. They continually reinvest in their core business, acquisitions, or new technologies to maintain a competitive edge.
Margin of safety: While technology-driven companies can sometimes be overvalued due to market hype, periods of market correction often present opportunities for value investors to enter positions when prices are more reasonable. This creates a margin of safety, one of the cornerstones of value investing, and an opportunity to invest in a high-quality business at a fair price.
What Legendary Investors Think of Technology Companies
For much of his career, Warren Buffett, chairman of Berkshire Hathaway, often known as the Oracle of Omaha, was cautious about investing in technology companies. His investment philosophy revolves around understanding a business’s long-term competitive advantages, and preferring stable, predictable industries. For years, Buffett avoided technology-driven companies due to its perceived volatility and rapid pace of change, admitting he did not fully understand the sector. However, his stance changed in 2016 when Berkshire Hathaway made a substantial investment in Apple. Initially a surprising move to many given Buffett’s long-standing avoidance of tech, he has since described Apple as more of a consumer brand than a traditional tech company, praising its loyal customer base and strong cash flow.
Since Berkshire Hathaway began purchasing Apple shares in 2016, it has made an estimated gain of over $100 billion. Berkshire bought Apple shares at an average price of around $36 per share (adjusted for the stock split), and with Apple now trading around $220 per share, the investment has grown roughly sixfold. In addition to stock price appreciation, Berkshire has benefited from substantial dividends, making Apple one of its most profitable investments to date in absolute U.S. Dollars terms. As of the writing of this article, Apple remains Berkshire’s largest publicly listed holding, despite the company selling around half of its position in the second quarter of 2024. This may suggest that Buffett believes the recent rapid rise in Apple’s share price is no longer fully supported by its fundamentals.
Buffett has referred to Apple as “probably the best business I know in the world”. This shift in strategy demonstrates Buffett’s recognition that certain technology companies, when they achieve durable market leadership and consistent earnings, can fit within his value investing framework.
Peter Lynch, fund manager of the Fidelity Magellan Fund, one of the most successful mutual fund managers of all time, built his reputation on finding growth companies at reasonable prices, an approach known as Growth At a Reasonable Price (GARP). While Lynch retired from active management before the rise of today’s technology companies, his investment philosophy offers insights into how he might view them. Lynch’s advice to “invest in what you know” could very well apply to Big Tech. Companies like Amazon, Apple, and Google are integral parts of everyday life, which aligns with Lynch’s principle of investing in businesses that consumers understand and use. While Lynch didn’t invest heavily in tech during his career, he likely would have appreciated the predictability and recurring revenue models that companies like Apple (via hardware sales and services) and Google (through digital advertising) have developed.
Conclusion
The evolving relationship between technology and traditional industries has led to a profound shift in how businesses operate and how investors approach the market. The historical division between tech and non-tech companies no longer holds true, as technology has become an integral part of virtually every sector. From retail to financial services and energy, the use of automation, artificial intelligence, cloud computing, and data analytics has blurred the lines between industries.
As the GICS reclassification in 2018 demonstrated, even companies like Google (Alphabet), Facebook (Meta), and Netflix, once considered technology businesses, are now classified based on their core business activities, such as digital advertising and media distribution. This highlights the need to reconsider the broad application of the term Big Tech. While the label remains popular for its simplicity and reflects the market dominance of companies like Apple, Amazon, and Google, it may no longer fully capture the multifaceted operations of these businesses.
For investors like Warren Buffett and Peter Lynch, who traditionally avoided technology stocks, the maturation of technology-powered companies into cash-generating, market-dominating businesses has made them more appealing. Buffett’s investment in Apple exemplifies how value investing principles can align with technology companies when they demonstrate consistent earnings, strong economic moats, and efficient capital allocation. Similarly, Lynch’s approach of investing in businesses people know and use daily would likely make today’s tech giants attractive candidates in his portfolio.
As technology continues to reshape industries and investment strategies, it’s clear that the line between traditional and tech companies will keep fading. What remains constant, however, is the need for level-headed investors to recognize the changing landscape, adapt their strategies, and focus on businesses that not only harness technology but do so in ways that drive sustainable value while purchasing them at attractive prices.