QOTD: Technology is the New Macro

The use of technology directly impacts a company’s profitability. Consider its impact on the calculation of a company’s return on equity. ROE is the product of three variables—profit margin, asset utilization, and leverage. To the extent that you can substitute technology for labor, your profit margin will rise, even if your revenue is flat. If you can substitute technology for assets (bricks and mortar), asset utilization will rise.

The third component of this calculation, leverage, is measured by dividing the company’s total assets by shareholder equity. If you don’t need as many assets to run a business, you can return excess capital to the shareholder by buying back shares, raising the cash dividend, paying down debt. In other words, the payout ratio can rise. Companies don’t need as much capital today because they have embraced technology. If you can find industries applying technology in this way, they will continue to grow, regardless of what happens with interest rates.

- Bill Priest, Epoch Investment Partners

Bill’s firm, Epoch, manages $47 billion in assets. The firm focuses on the generation and reinvestment of free cash flow, which gives him a unique perspective on how technology is changing the way corporations operate thanks to new tools and available processes. Using technology as a macro input is a good way of thinking about valuations, I think. The story isn’t just tech stocks, it’s what non-tech companies are now able to do because they’re using tech.