When the subject is US technology stocks is broached, the first port of call for many is the FAANG stocks – a catch-all acronym for some of the biggest companies in the world: Facebook (FB), Apple (AAPL), Amazon (AMZN), Netflix (NFLX) and Google owner Alphabet (GOOGL).
It’s no surprise, of course, as these stocks have rewarded investors handsomely over the years. In the past five years, the only one of these five companies that wouldn’t have doubled investors’ cash in US dollar terms was Google. Since the most recent of the IPOs in 2012, Apple’s 160% is the worst you’d have done.
In more recent times, though, gains have been harder to come by. Facebook, for example, is 8% lower than where it was this time last year, even after its recent rally. Over six months, Netflix, at 0.36%, is the only stock in positive territory.
While tech stocks rallied in January just as strongly as they sold off in the last three months of 2018 after decent results, it’s getting harder for investors to justify the investment case.
Analyst forecasts show the quintet are expected to grow net income by just 0.6% in 2019. That comes after a year when operating profit and free cash flow growth had also slowed to zero, investment spending began to accelerate and regulatory pressure increased.
If you asked an investor whether they would be willing to pay $2.9 trillion for a company like that, they would probably laugh at you, suggests Russ Mould, investment director at AJ Bell. “But this is exactly what investors are currently being asked to do in the case of the FAANG stocks,” he adds.
Granted, those analyst forecasts look much more palatable in future years. Net income is likely to grow at 19.6% in 2020 and 22.5% the following year. On those numbers, it could be argued four of the five – Netflix is the exception – look fairly valued on 2021 price/earnings multiples of between 12% and 17%.
But that they will be able to deliver on these forecasts must be taken on trust, considering the headwinds surrounding them. Mould notes they are teetering on bear market territory. The NYSE FANG+ index – which also encompasses Nvidia (NVDA), Tesla (TSLA), Twitter (TWTR) and China’s US-listed Alibaba (BABA) and Baidu (BIDU) – is still 15% below its June 2018 peak.
Chris Teschmacher, fund manager within Legal & General’s multi-asset asset allocation team, is still keen on the tech sector. His LGIM Multi-Asset Target Return fund has been long tech since the beginning of 2018.
“We think there’s still better earnings growth potential than the broader market, they have the ability to cut costs if we have a recession or a slowdown,” says Teschmacher.
Income and Value in Technology Stocks
But technology is a broad sector, with plenty of alternative names around. Further, while valuations as a whole are still expensive relative to other areas of the market, they are much lower than before the dotcom bubble and the majority of firms today are backed by both profits and cash on their balance sheet.
“In 2000, there were a bunch of bad businesses that traded at crazy multiples and the net result was disastrous for investors,” explains Mike Seidenberg, portfolio manager on the Allianz Technology Trust (ATT).
“We’re living in a world now where when I see companies go public, for the most part they’re real businesses solving real problems. And because it’s less of a bubble, you’re not seeing egregious valuations.”
While not an obvious place to go looking for yield, income investors are beginning to see tech as a key area. “Now the information technology sector is maturing, you’re now starting some good yields combined with pretty decent growth,” says Ben Peters, co-manager of the TB Evenlode Global Income fund.
Matthew Page, manager of the Guinness Global Equity Income fund, agrees and his fund has long-term holdings in both Microsoft (MSFT) and Cisco Systems (CSCO). Cisco has gone from not paying a dividend in 2010 to a yield of 2.8% today.
Allianz Technology has big positions in both Amazon and Google – and recently added Facebook to the portfolio – but offers a broader exposure to technology. It doesn’t own Apple and has more than half its portfolio invested in small and mid-cap names.
Identity management firm Okta (OKTA) and cloud-based solutions provider Paycom Software (PAYC), valued at around $9 billion each, are the fourth and fifth largest positions.
One firm Seidenberg likes is Workday (WDAY), which provides next-generation human resources solutions for large organisations. It has one of the highest net promoter scores the team has ever seen, showing its popularity with customers.
“Our thesis when buying the stock was we thought it could have the chance for a really good second product,” he recalls. “That is coming to fruition, which gives us another avenue of growth for the next three or four years.”
While the firm is “richly valued” and Seidenberg would think twice about adding at current levels, he would look to top up should there be another pull back.
Good Value Opportunities
On a similar, HR solutions note, Paychex (PAYX) was recently added to the Guinness fund. While the firm’s main business is in payroll processing, it has broadened into other outsourced HR functions.
It’s been on the radar since the fund’s inception in 2010 and was sold off at the end of 2018 to what was a seven-month low. “It doesn’t quite fit with our ‘great company at a good price’ process; it was a great company at a good price”, says Page.
It’s an acquisitive company and has success in buying up smaller businesses and integrating them well. “It’s quite a predictable business and very scalable,” Page adds. “It’s also quite a good play on the strength of the US employment market.”
For value investors, too, it is showing signs of attractiveness. Technology is the largest sectoral position in the Morningstar Bronze Rated Fidelity American Special Situations fund. “The sector contains some very expensive companies,” says manager Angel Agudo, “but also some good value opportunities.”
The fund also holds Cisco, but also currently likes semiconductor firm Qualcomm (QCOM) as a play on growing adoption of 5G, as well as Check Point (CHKP), which is a significant player in the US cyber security market.
“Check Point is a quality company with a good management team, which is maintaining market leadership via adoption of the latest technology and strategic thinking,” Agudo says.
One area Seidenberg is cautious on now is China. The trust sold all its Chinese holdings when Donald Trump was elected as President of the United States. “We were very worried about how he would handle China,” he explains.
“We have traditionally been very early and big investors in China and I think it is important that we go back, but until there is a resolution [on trade] we will avoid things like Tencent (00700).”
