Fifteen years since the dotcom bubble burst, quality technology stocks are delivering some all-time highs, albeit against a very different landscape. But are the household names always the best bets?
The sector has matured significantly; in 2000, the ‘world wide web’ was a nascent entity, many companies were failing to monetise their business models effectively, forecasting was typically based on uncharted territory and infrastructure overcapacity was common.
As well as such fundamental differences, valuations have come down to much more reasonable levels; today the sector is trading at around 15x price/earnings rather than 60-plus multiples typical at the turn of the millennium.
Managers’ Favourite Tech Stocks
While Fidelity’s HyunHo Sohn, who runs its Global Technology fund, believes simplistic 'big versus small' arguments are inappropriate in today’s risk-off world, a handful of giants are certainly powering the sector’s performance right now as investors flock to safety.
Amazon (AMZN), Microsoft (MSFT), Alphabet (GOOG) (formerly Google) and Facebook (FB) have contributed almost 100% of the sector’s returns this year, according to Walter Price, who runs the Allianz Technology Trust (ATT).
“I think it has been a very concentrated market with just a few stocks doing well and the rest not doing so well,” he said. However, while those four leaders have contributed significantly to his fund’s performance, their growth levels more than twice lag much of the peer group.
“When companies [like Google and Amazon] with annual growth of only 20% are selling at the same multiples of revenue as those with 40 or 50% growth, it means something is wrong—the companies growing fast need to become more profitable. I think that is going to happen in the next year—they will catch up as their profitability improves.”
With the largest positions in Alphabet and Facebook amongst his UK-domiciled peer group, Price described Tesla Motors (TSLA) as one holding that has served him particularly well, despite it not being classified as a technology stock by definition.
Further, he suggested the ‘internet of things’ was generating a lot of success for the semiconductor industry as it enables the use of technology on the move. He names Freescale Semiconductor (FSL) and high-end audio manufacturer Harman International Industries (HAR) as two holdings benefiting indirectly from technology.
Tech’s Unsung Heroes
One issue facing some of the larger, established industry leaders is the rate of change.
“Every couple of decades, the technology sector goes through a fairly major platform shift,” explained Jeremy Gleeson, manager of the Axa Framlington Global Technology fund.
“In the sixties you had the mainframes, the mini-computers of the seventies and eighties that led to the PC market, then client service architecture and now we are fairly early into the cloud computing cycle.”
Amazon—described as “eating the world” by Price and having risen more than 112% this year to a decade-long high—is seen as leading cloud computing, along with Microsoft. But perhaps another ‘one to watch’ is Salesforce.com (CRM), up almost 34% this year.
While Salesforce.com has graduated from its mid-cap ranking into a $52 billion business, validating Gleeson’s penchant for small- and mid-cap companies, managers are already eyeing those set to follow in its success.
Price has named Workday (WDAY), ServiceNow (NOW) and Zendesk (ZEN) as benefiting their customers through cloud-based shared infrastructure and productivity engines. "These companies are not getting enough credit," he added. That said, few of these companies highlighted by tech managers are currently trading at attractive valuations according to Morningstar analyst estimates.
Offering a similar service to Salesforce.com but designed for IT professionals, Gleeson and Price agree that ServiceNow's lack of legacy means it was able to innovate more rapidly than the major players it competes with—namely IBM (IBM), Hewlett-Packard (HPQ), BMC (private equity-owned) and CA (CA).
“None of these four have introduced a ‘next generation’ platform for their companies and customers are now migrating quite significantly to ServiceNow,” said Gleeson.
With Amazon putting pressure on so many facets of the market, one winner by proxy this year is retail supply chain management software firm Manhattan Associates (MANH). Gleeson said his holding has benefited from a 40% rise in the share price since he took the position in March.
Hot Topics and Risks
"Retailers are under increasing pressure from competition such as Amazon and from changes in consumer behaviour such as buy online, click and collect, click and collect from another store."
As consumers want a more multi-channel retail experience, the size of Manhattan's addressable market has possibly tripled, he said.
Other hot topics include virtual reality—no longer just the domain of video games but venturing into military simulation, education and training, and automation—in particular driverless cars, the ‘smart tech’ revolution, and artificial intelligence, according to HyunHo Sohn.
He said some major challenges for the sector include protectionism, such as that seen recently by Chinese governmental blocks on certain US tech companies and also cybersecurity—both a blessing and a potential curse.
“While on one hand it drives demand for the software, but if the big data becomes hacked then it poses a risk to the entire tech industry. That might be a low probability but it is probably one of the biggest risks facing the sector as a whole,” he concluded.
