From Goldfish to Whale: Can Upstart Tech Challengers Displace the Big Five?

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Are hungry, savvy disrupters going to bump aside the digital giants? The Big Five tech stocks—Apple, Microsoft, Alphabet, Amazon, and Facebook—dominate the stock market these days, and, aside from the occasional temporary dip, they seem a sure bet to continue that hegemony. But nothing lasts forever, especially in the protean technology field, where disruption is a given.

Think back to the 1960s, when Xerox, Eastman Kodak, and International Business Machines (IBM) commanded the heights of tech. Today, they are pale facsimiles of their former selves. America Online (AOL), Compaq, and Digital Equipment Corporation (DEC) were in the pantheon of 1990s tech leadership. They’re mostly memories now.

In the future, what tech challengers could supplant the Big Five? Odds are that tomorrow’s stars will be dedicated to what’s called “the internet of things,” meaning a vast interconnection that runs the world, from transportation to manufacturing to health care, and on and on.

“That’s the next phase, involving artificial intelligence [AI] and productivity enhancers,” said Paul Colonna, president and CIO of Lockheed Martin Investment Management. Nowadays, the Big Five are more oriented toward the consumer, he noted, although of course they also have significant presences in business applications (Microsoft’s Office software, for instance).

Certainly, many possible disrupters are in their early stages, and only a handful will rise to prominence. The potential for the right companies is palpable, though. For instance, the health care sector is ripe for introducing algorithm-driven and AI-aided diagnosing, said John Decker, lead portfolio manager of Greenwood Capital’s small- and mid-cap equity strategy. Rising companies in this area “have tons of data” to marshal and deliver better medical outcomes, he said.

While it’s impossible to say which of the ambitious pack of wannabe tech titans is slated for glory, a number of these tyros are “a good place to put capital,” said Mark Baumgartner, CIO of Carnegie Corporation, whose portfolio has investments in venture capital (VC), which is developing such up-and-comers.

The tech leaders “won’t be the same in 10 years,” predicted Nancy Prial, co-CEO of Essex Investment Management. Identifying who the real up-and-comers are right now is no simple feat. Early on, few could pinpoint the firms that became the Big Five.

In 1996, for example, Google began as a research project of two Stanford Ph.D. candidates, Larry Page and Sergey Brin, who were convinced they could build a better search engine than the ones available then. They launched their company in 1998. At the time, Yahoo was the ruling force in search, and a formidable one. Other entrenched competitors included Lycos, Ask Jeeves, and AltaVista.

By 2004, when it went public at $85 per share, Google had become the primo search juggernaut. In 2021, Google-parent Alphabet is the third largest company on earth by market capitalization—it weighs in at $1.9 trillion. If you invested in its initial public offering (IPO), your money would’ve expanded 34-fold.

In fact, the Big Five are an almost-exclusive club at the top stratum of global market caps, with Apple No. 1 ($2.6 trillion) and No. 6 Facebook at the tail end ($1.1 trillion). Only Saudi Aramco, the Saudi Arabian oil and gas company, intrudes in this lofty US-centric imperium, in fourth place at $1.9 trillion. Small wonder that, to many on Wall Street, the tech quintet seems impregnable.

Are the Big Five Really Unstoppable?

Beyond these mega-caps, tech in general seems to have a lock on the future, which means there is fertile ground to produce the next disrupting behemoths via copious VC and angel funding. No one has invented a perpetual motion machine, but Wall Street has the closest approximation in tech companies.

Technology’s increases have been phenomenal. Over the past decade, the tech industry’s average growth rate has been almost triple that of the US gross domestic product (GDP), according to Nancy Tengler, CIO of Laffer Tengler Investments, at 6.5% annually versus 2.3%.

And the colossuses of this blessed sector have shown the most breathtaking advances of all. Going back 10 years, the Big Five made up 7.3% of the S&P 500; today, that portion has expanded to 23.3%, according to Bloomberg data. The pandemic has done much to speed their progress: The mega-caps’ share of the index was 19% at the end of 2019, and their gains since illustrate a daunting resilience amid economic turmoil. What’s more, the rollout of 5G networks should propel smartphone sales and usage of cloud-based storage and social networks.

The Big Five have enormous advantages. Their very size and bottomless cash stashes enable them to gobble up potential competitors, as they effortlessly expand into other areas they hope will complement the core business and plump the bottom line. Amazon, for example,  bought upscale supermarket chain Whole Foods in 2017 (for $13.7 billion) to enlarge its retail footprint, self-driving car company Zoox in 2020 ($1.2 billion) for ride-hailing and deliveries, and film studio Metro-Goldwyn-Mayer this year ($8.5 billion) to strengthen its entertainment and streaming efforts.

True, upward trajectories are never smooth. As IBM and others demonstrated, dips can turn into free falls, depending on business models and how they keep up with new trends and tech breakthroughs. Amazon has seen its remarkable e-commerce run wobble a bit lately as some consumers returned to physical stores. Apple’s iPhone production is suffering currently from parts shortages resulting from supply bottlenecks and last year’s lockdowns.

The recent past has shown that Big Tech’s market leadership isn’t 100% unassailable. Earlier this year, as vaccinations surged and the pandemic’s end seemed near, the market went through a “rotation”—where leadership passed from the tech mega-caps to re-opening plays such as entertainment and leisure, along with banks. These value stocks had a moment at the head of the parade, then dwindled with the onset of the Delta variant and predictions that economic growth might flag again.

An even bigger threat is stepped-up government scrutiny and antitrust talk, both in the US and Europe. Facebook did score a victory in June when a federal judge threw out a Federal Trade Commission (FTC) antitrust action. But the agency came back last month with an amended complaint, taking a different tack. Lina Khan, the FTC’s new chief, is a fierce critic of Big Tech’s power. The US House Judiciary Committee just passed a framework that could potentially lead to busting up the major tech outfits.

The European Commission, which is the European Union’s executive branch, has laid out an antitrust case against Amazon that claims the company secretly uses the data of its platform’s third-party merchants to compete against them. (The online retailer denies the charge.)

Government antipathy isn’t a big issue yet in the stock market. Research shop Evercore estimates that the regulatory scrutiny has shaved 10% off the Big Five’s prices—which is like saying their returns were just marvelous, instead of fantastic. At the same time, there’s a school of thought on Wall Street that breaking up the tech megaliths could unlock value, further foster innovation, and benefit investors even more. That’s pretty much what resulted from the 1984 dismemberment of the AT&T phone monopoly.

Some Potential Disrupters

We asked several well-respected money managers to suggest possible companies that could rise high and possibly supplant the Big Five, or some of them anyway. Nobody, of course, would make a firm prediction, as the market’s future is unknowable. Still, their ideas are food for thought.

Shopify “has significant momentum challenging Amazon” in e-commerce, according to Dave Mazza, head of product at Direxion. The Ottowa-based company has the largest market cap of any firm in Canada, at $191 billion, and its stock has almost tripled since the March 2020 market nadir. It has caught on as an alternative to Amazon, whose large operation selling third-party goods comes with a bunch of restrictions. Shopify, targeting businesses that want online sales without the Amazon hassle, swung into the black last year, as revenue catapulted. One downside: Shopify, with shares priced at 78 times earnings, is more expensive than Amazon.

To David Barse, founder and CEO of XOUT Capital, health care is a prime area in need of technological help. Many critics have lambasted the medical establishment’s antique ways in everything from diagnostics to administration. A good remedy is fast-growing Teladoc Health, which provides online doctors’ appointments and other medical care, he said. The pandemic has given the company a boost, with the stock rising 14% since the start of the nation’s lockdown in early 2020, as revenue doubled. The stock is a favorite of market guru Cathie Wood, Barse pointed out.

Amtech Systems, whose share price has doubled since early last year, shows promise, said Essex’s Prial. The company provides the equipment that makes microchips. She said the incipient trend to bring chip manufacturing back to the US should help Amtech. Another contender, she added, is Impinj: The stock has more than tripled since the March 2020 low. This company started out making radio-frequency identification (RFID) gear for airport luggage, and from there has moved into the supply chain, with its tags used to track inventory in retail outlets and warehouses.

Haptic technology is the realm of Immersion, a profitable outfit that has seen its stock leap 45% since last year’s trough. Haptics provide a computer simulation of motion and touch, such as in Sony’s PlayStation 5, for video games specializing in the likes of warfare and sports. Immersion also furnishes the vibration notifying iPhone owners of incoming messages and calls. The firm’s future is bright because “the use of haptics will double” said Greenwood’s Decker.

Back to the Future

One possible problem for the Big Five is that at some point they might price themselves out of the market, or at least give lower-priced rivals an opening. These monster companies are, for the most part, way expensive: Apple’s trailing price/earnings (P/E) ratio is 30, more than twice the S&P 500’s historical norm. Amazon is at 60, Alphabet 31, Facebook 28, and Microsoft 37.

That caveat aside, a strong case exists that the Big Five possess so much strength and innovative elan that their prices have room to run. This is the argument of Rafael Resendes, co-founder of the Applied Finance Group, who maintains that traditional accounting fails to capture innovation wrapped up inside the giants.

Hence, Facebook’s buying text-based messaging outfit WhatsApp and virtual reality headset provider Oculus is not reflected in the social network firm’s price, and “it’s as if Facebook has zero sales growth,” said Resendes. Big tech must immediately write off massive research and development (R&D) outlays—counting the R&D as an expense, not an investment in the innovation that fuels their companies. Buyers of tech stocks “need to clean up the distortions” that mislead them about valuations, he said.

Undeniably, the tech A-team up to now has shown they are capable of innovation, the antithesis of smug, stodgy giants that can’t change with the times. Their eagerness to acquire bolt-on businesses demonstrates that spirit.

Look at how two of them have changed direction to stay abreast of a changing world. Microsoft, which made its name as a software developer, pivoted into the internet and networking in the late 1990s and over the past decade has established itself as a major presence in cloud computing. More recently, the company launched its Teams offering, to compete with work-from-home hotshot Zoom Video. “The empire struck back,” Direxion’s Mazza said.

Apple, known for its personal computers, faced decline until co-founder Steve Jobs returned—and steered the company into handheld devices. Before the turnaround, when XOUT’s Barse was CEO of Third Avenue Management, “We sold Apple. If we had held on, we’d have had an increase” of 300 times its price then.

For the time being, a lot of investors are entranced by the Big Five’s prospects. The tech mega-caps may take a permanent pratfall, just not now.

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