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The stocks to watch this decade

Susan Dziubinski  |  22 Jan 2020Text size  Decrease  Increase  |  
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We kicked off the 2020s in the way many other financial sites did: with stock picks for the new decade. We culled ideas from the Morningstar Exponential Technologies Index.

Today, we return to the index in a quest for additional stock picks; we’re taking a look at the index’s constituents through a slightly different lens.

But first, some background. The Morningstar Exponential Technologies Index is designed to identify companies across sectors in the early stages of developing or using transformative technologies.

(For tips on buying international shares, see Prem Icon Morningstar Guide to International Investing)

It features 200 companies identified by Morningstar's equity research team as being positioned to experience meaningful economic benefits as a user or producer of promising technologies.

Morningstar has identified nine technology themes.

Big Data and Analytics: Capabilities with data sets too large and complex to manipulate or interrogate with standard methods or tools. Related subthemes include the "Internet of Things," machine learning, and artificial intelligence.

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Networks and Computer Systems: Technology leaps ranging from hyperconnectivity and integrated systems, to service continuity and new software-defined architectures, will have a massive impact on the way people think of connecting applications and software with hardware.

Nanotechnology: The branch of technology that deals with dimensions and tolerances of less than 100 nanometers, especially the manipulation of individual atoms and molecules. We see a range of potential applications spanning medicine, computing, manufacturing, and travel.

Medicine and Neuroscience: Sciences, such as neurochemistry and experimental psychology, that deal with the nervous system and brain. Key advancements in unlocking the human genome have created an infrastructure of biomarkers, while paradigm shifts in biotechnology that can alter the immune system are radically changing the way we treat diseases.

Energy and Environmental Systems: This involves the exploration of renewable energy sources—including solar, wind, water, and batteries. As organisations set processes to help reduce environmental impacts and increase operating efficiency, new avenues for technological advancement across sectors will open up.

Robotics: The branch of technology that deals with the design, construction, operation, and application of robots. Advances in robotics, specifically when combined with other exponential technologies, have seemingly infinite potential applications, spanning technology, industrial, medical, and consumer-facing channels.

3D Printing: A process for making a physical object from a three-dimensional digital model. The emerging trend is ready for mainstream consumption and has ample potential to disrupt several industries, from industrial manufacturing and medicine, to consumer products and retail.

Bioinformatics: The science of collecting and analysing complex biological data. The "quantified sell" trend of acquiring data to quantify aspects of an individual's daily life has exponential potential to positively affect both the duration and quality of life.

Financial-Services Innovation: The search for and acknowledgement of emerging funding sources, platforms, currencies, and stored and transferred value. We not only think about opportunities to efficiently expand production but also the underlying currencies used (including cryptocurrencies), as well as structural shifts in technology and payment delivery methods.

Analysts score companies within those themes on a scale of 0 (no or little exposure to the theme) to 2 (significant exposure), relying on models to project growth over five, 10, and 20 years. We've isolated the 10 companies that our analysts cover with the highest overall scores.

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Not surprisingly, the list includes the three stocks we featured in our previous article, which focused on companies in the index that are leaders in more than one theme: Illumina (NAS: ILMN), Google (NAS: GOOGL), and Bristol-Myers Squibb (NYS: BMY).

Here's a little bit about the other names on the list. Although nearly all of these stocks are fairly or overvalued today according to our metrics, they deserve a spot on your watch list.

Apple (NAS: AAPL)
Economic moat: Narrow
Current rating (as of 22 January 2020): 2 stars

“Apple’s competitive advantage stems from its ability to package hardware, software, services, and third-party applications into sleek, intuitive, and appealing devices. This expertise enables the firm to capture a premium on its hardware, unlike most of its peers. Despite its admirable reputation, loyal customer base, and unique products, the consumer hardware space can be unforgiving to firms unable to consistently satiate the customer’s appetite for more features. Given the short product cycles of Apple’s products and army of firms targeting its dominance, we do not believe Apple has a wide economic moat.

Switching costs and intangible assets support Apple's narrow moat. The firm enjoys stellar returns on its devices by offering a unique user experience with its iOS ecosystem. Contrary to its peers in PCs and smartphones that rely on relatively open operating systems, Windows and Android, respectively, Apple’s walled garden approach for its popular iOS allows it to charge a premium for relatively commoditized hardware not too different from that sold by Samsung, Dell, and others. Customer switching costs are elevated for Apple users as a non-Apple iOS experience does not exist, unlike computing platforms for the Windows or Android ecosystems that boast PCs and smartphones from a multitude of firms.

We view the iPhone as a revolutionary product that created the smartphone ecosystem and transitioned computing habits away from the PC. The robust app store helped foster iPhone adoption and grow Apple’s user base, with applications ranging from productivity, social media, gaming, music, and so on. We foresee Apple's ongoing business coming from existing customers versus new smartphone adopters. With hardware becoming increasingly commoditised and replacement cycles potentially elongating in the long term, we expect Apple to focus on newer software and services to augment the user experience and retain customers. The firm’s additional products and services (Apple Watch, iCloud, Apple TV+, AirPods, Apple Pay) act as both supplemental revenue opportunities and, more importantly, critical enhancements to the iOS ecosystem that support Apple’s crown jewel: the iPhone.”

Abhinav Davuluri, strategist

Intel (NAS: INTC)
Economic moat: Wide
Current rating (as of 22 January 2020): 3 stars

“Intel is the leader in the integrated design and manufacturing of microprocessors found in PCs and servers. With the rise in interconnectivity of devices, Intel strives to provide the most powerful and energy-efficient silicon solution to any product 'smart and connected'. The data centers used to facilitate the information stored, analysed, and accessed by various front-end devices are mostly run with Intel server chips.

Intel differentiates itself first and foremost via the continued execution of Moore's law, which predicts transistor density on integrated circuits will double about every two years, meaning subsequent chips have substantial power, cost, and size improvements. This scaling advantage is perpetuated through higher-than-peer-average R&D and capital expenditure budget that allows it to control the entire design and manufacturing process in an industry where the majority of competition focuses on only one phase. While the firm has had issues with its 10-nanometer process in recent years, we expect the firm to get back on track with its 7-nanometer process in 2021 with the help of EUV lithography.

As cloud computing continues to garner significant investment, Intel's data centre group will be an indirect beneficiary. Mobile devices have become the preferred device to perform computing tasks and access data via cloud infrastructures that require considerable server build-outs. This development has provided strong tailwinds for Intel's lucrative server processor business. We believe the Altera acquisition will help Intel maintain its recent growth trajectory in the space, as customers increasingly seek out customised server solutions that use FPGAs.

The proliferation of mobile devices has come at the expense of the mature PC market, Intel's historic stronghold, with ARM and its cohorts joining AMD as chief rivals. The rise of artificial intelligence has also unleashed a new competitor in Nvidia for specialised chips to accelerate AI-related workloads. Consequently, Intel has built a broad accelerator portfolio via the acquisition of Altera for FPGAs, Mobileye for computer vision chips used in cars, Nervana neural processors, and Movidius VPUs.”

Abhinav Davuluri, strategist

Tesla (NAS: TSLA)
Economic moat: None
Current rating (as of 22 January 2020): 2 stars

“Tesla has a chance to be the dominant electric vehicle firm and is a leader in autonomous vehicle technology, but we do not see it having mass-market volume for at least another decade. Tesla's product plans for now do not mean an electric vehicle for every consumer who wants one, because the prices are too high. The Model X crossover released in late 2015 starts at about US$85,000 ($124,300), but will average much higher with options. The Model S sedan's starting price is about US$80,000. The Model 3 sedan starts at US$39,490 and rolls out gradually through 2019 in other variants in foreign markets. Prices are before any tax credits, and the US federal tax credit stops at the start of 2020.

Tesla is building its gigafactory—a lithium-ion battery plant under construction in Nevada—to help it produce at least 500,000 vehicles at its sole assembly plant in Fremont, California. CEO Elon Musk said in 2018 that total output in 2020 could be as much as 1 million vehicles, but that will not all be in California. A Shanghai plant opened in late 2019 and is wholly owned by Tesla. We are sceptical of the 1 million number, given Tesla sold about 245,000 vehicles globally in 2018. Even if demand exists for these vehicles, this quantity is small relative to total global auto production, which should reach 100 million units in the next few years. Thus, we think global mass adoption of pure electric vehicles is still a way off.

In the meantime, Tesla will have growing pains, possibly recessions to fight through before reaching mass-market volume, and increased its debt levels by acquiring SolarCity to become a vertically integrated sustainable energy company. It is important to keep the hype about Tesla in perspective relative to the firm's limited production capacity. Tesla's mission is to make EVs increasingly more affordable, which means more assembly plants must come on line to achieve annual unit delivery volume in the millions. This expansion will cost billions a year in capital spending and research and development and will be necessary even during downturns in the economic cycle. Tesla also has more vehicles to launch, such as a pickup truck, that will demand lots of capital.”

David Whiston, strategist

Microsoft (NAS: MSFT)
Economic moat: Wide
Current rating (as of 22 January 2020): 3 stars

“Since taking over as CEO in 2014, Satya Nadella has reinvented Microsoft into a cloud leader that has become one of only two providers that can deliver a wide variety of platform-as-a-service/infrastructure-as-a-service solutions at scale. Microsoft has accelerated the transition from a traditional perpetual license model to a subscription model and embraced the open-source movement. Also, Microsoft exited the low-growth, low-margin mobile handset business and is driving gaming to be more cloud-based. These factors have turned Microsoft into a more focused company that offers impressive revenue growth with high and expanding margins.

We believe Azure is the centerpiece of the new Microsoft. Even though we estimate it is already an approximately US$7 billion business, it grew at a 92 per cent rate in fiscal 2018. Azure has several distinct advantages, including offering a painless way to experiment on moving workloads to the cloud. Since customers remain in the same Microsoft environment, applications and data are easily moved from on-premises to the cloud. Microsoft can also leverage its massive installed base of Microsoft solutions as a touch point for an Azure move. Azure also continues to launch new services in the secular trends of artificial intelligence, business intelligence, and “Internet of Things.”

Microsoft is also shifting its on-premises products to become cloud-based SaaS solutions, including LinkedIn, Office 365, and Dynamics 365. Like any transition, the initial move is painful, as both revenue and margins drop. However, Microsoft is now on the back end of that, where revenue has accelerated and is more predictable and margins are increasing. Office 365 retains its virtual monopoly in office productivity software, which we do not expect to change anytime soon. We believe that customers will continue to drive the transition from on-premises to cloud solutions, and revenue growth will remain robust, with margins continuing to improve for the next several years.”

Dan Romanoff, analyst

Stryker (NYS: SYK)
Economic moat: Wide
Current rating (as of 22 January 2020): 2 stars

“Stryker remains a top-tier competitor in several attractive medical markets, including orthopedic implants, medical and surgical equipment, and neurovascular products. It enjoys a long record of innovation in its key markets, and we anticipate the pattern will continue, allowing the wide-moat company to earn attractive economic profits.

In contrast to rival Zimmer Biomet, Stryker has sought to diversify and ease its reliance on large joint reconstruction. The benefit of this strategy became clear as the Great Recession pushed the orthopedic market into slow-growth mode, demonstrating that the historically recession-resistant business was indeed vulnerable when many uneasy patients deferred elective procedures. Stryker is also relatively less vulnerable to increased pricing pressure on hips and knees. We have always liked Stryker's presence in the medical-surgical equipment area, as it offers a measure of stabilisation and diminishes the impact of periodic economic downturns. The varied product lines also mean Stryker has more opportunities to engineer meaningful innovation, which is critical to gaining pricing advantages. Stryker continues to pursue its strategy of augmenting internal innovation with acquisitions of specific technology, including Patient Safety Technologies, Small Bone Innovations, Sage, Mako, and K2M. This fits into the firm's larger goal of partnering more closely with its hospital customers across multiple device and equipment categories.

While we see few opportunities for optimizing synergistic innovation across Stryker's divergent business segments, the extensive breadth of products should, nonetheless, serve Stryker well as hospital customers seek to consolidate suppliers in order to take advantage of volume discounts. Moreover, Stryker management has demonstrated an acute understanding of new opportunities for med-tech competitors that have arisen thanks to the shift toward value-based reimbursement that has squeezed providers. We anticipate Stryker will continue to make strategic acquisitions of technology and products that aim to avoid complications or cut costs.”

Debbie Wang, senior analyst

Amazon.com (NAS: AMZN)
Economic moat: Wide
Current rating (as of 22 January 2020): 4 stars

“Amazon's disruption of the retail industry is well documented, but the company continues to find ways to evolve its business model. Its operational efficiency, network effect, and a brand intangible asset built on customer service provide its marketplaces with sustainable competitive advantages that few, if any, traditional retailers can match. The combination of competitive pricing, unparalleled logistics capabilities and speed, and high-level customer service makes Amazon an increasingly vital distribution channel for consumer brands. Even with more retailers looking to expand online, we believe Amazon will maintain its consumer proposition through Prime expedited shipping, an expanding digital content library, and new partnerships from its Whole Foods acquisition. Aided by more than 460 million estimated global active users, more than 140 million global Prime members, and fulfillment infrastructure, technology, and content investments, Amazon owns one of the wider economic moats in the consumer sector and is likely to reshape retail, digital media, enterprise software, and other categories for years to come.

Key top-line metrics—including active users (a 12 per cent compound annual growth rate the past five years), total physical and digital units sold (23 per cent CAGR), and third-party units sold (30 per cent CAGR)—continue to outpace global e-commerce trends, suggesting that Amazon is gaining share while fortifying its network effect. On top of its impressive growth, Amazon is building a more visible margin expansion story despite investment requirements for Prime one-day shipping (including fulfillment infrastructure/capacity), content deals, AmazonFresh, hardware such as the Echo/Alexa-enabled products, new delivery technologies, and physical store expansion. While some capital decisions haven't always yielded strong returns, we're optimistic that Amazon can grow to and sustain 9 per cent operating margins by 2023 based on Prime adoption and new pricing tiers, new subscription services across multiple categories, AWS segment margins around 35 per cent, fulfillment center scale, new third-party seller services, expanded advertising offerings, and Alexa technology licensing arrangements.”

R.J. Hottovy, strategist

Intuitive Surgical (NAS: ISRG)
Economic moat: Wide
Current rating (as of 22 January 2020): 1 star

"The company [has] continued to gain momentum in general surgery, with hernia and colorectal procedures enjoying robust growth. Meanwhile, mature procedures, such as dVP and dVH, enjoyed an unexpected renaissance, largely due to factors unlikely to repeat. With total procedure growth at the highest level since 2012 (when total volume was half what it is now), Intuitive's performance defied our expectations. However, we caution that growth is very likely to moderate even if the company continues to discover pockets of opportunity.

We don't consider our long-term thesis on the company particularly conservative. Even with the company's procedure volume now exceeding 1 million, we think the total addressable market several times the size still offers the company ample growth opportunities, particularly overseas. The ultimate ceiling for robotic surgery is virtually unlimited, with existing applications only scratching the surface of all possible procedures that could migrate to the robot. A number of categories still offer sizable unpenetrated and underpenetrated opportunities, both in and outside the US. Robotic surgery's acceptance in most of the developed world is significantly lower than in the US, and in the absence of formidable competitors (for now), Intuitive Surgical should continue to dominate the robotic surgery arena.

We do believe that growth will start decelerating in a number of procedures, with penetration rates hitting a ceiling in areas such as dVP. We also believe that the company will increasingly run into manual laparoscopy as a viable alternative (particularly in high-volume procedures such as appendectomy) and will need to continue supplying practitioners with tangible evidence of the benefits of robotic surgery on the clinical as well as economical fronts. The company will increasingly rely on growth internationally, where it has seen more scepticism in the past. That said, we believe Intuitive's competitive positioning remains superb, and while system sales will probably never reach growth rates of the past, the company still has a healthy growth profile.”

Alex Morozov, director

 

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