Market Views: How to avoid overpaying for tech investments

The advent of Covid-19 has accelerated the appeal of technology and data stocks, and raised their valuations. How should long-term focused investors get exposure without overpaying?
Market Views: How to avoid overpaying for tech investments

Technology and data companies were already the darlings of investors, courtesy of their ability to disrupt old economy stocks, often offering services or goods cheaper and faster. Covid-19 has only accelerated their appeal. 

As economies across the world locked down, households have consumed more online entertainment, bought more products and services over the internet and conducted business via online communication. That's only helped e-commerce and service companies to thrive. 

It has also caused their valuations to rise. The Nasdaq 100 index has seen its value increase by 20.18% from the beginning of the year to Wednesday (July 29), and it has soared by 52.45% from its lowest yearly close of 6,994.29 on March 18. Equity valuations for tech companies now look quite high, while many analysts have begun to assess tech companies on their growth prospects rather than their outright profitability.

In particular, this gain has centred on the largest companies, which presents challenges. Concerns about potential anti-competitive practices led the US House of Representatives to conduct lengthy questioning of the leaders of Amazon, Google, Apple and Facebook on Wednesday (July 29).

This is also concerning asset owners. As Shahril Ridza Ridzuan, managing director of Malaysian sovereign wealth fund Khazanah, noted on a webinar hosted by OMFIF on the same day, "when you look at how market behaviour is changing, quite clearly the bigger tech companies will continue to dominate and extend upwards". 

This offers investors a quandary: should they invest now, despite mounting prices and domination by a handful of companies, or seek other ways to gain exposure to technology in ways that may prove to be better bargains over the long-term. AsianInvestor asked seven experts their views on how best to invest in tech. 

The below responses have been edited for clarity and brevity. 

Nick Beecroft, equity portfolio specialist 
T. Rowe Price

Nick Beecroft

The economic and social consequences of the pandemic appear to have accelerated the rise of dominant technology platforms in retail, social media, streaming content and remote conferencing. We expect behavioural changes to be permanent. This trend is likely to widen the divide between industries and companies that benefit from disruption and those challenged by it.

We would acknowledge that in the near term valuations for some perceived ‘Covid winners’ feel very full, such as for the software industry. But this is nothing like the technology bubble of 20-years ago. These are high-quality businesses generating tons of cash flow and backed by strong balance sheets.   

In other parts of tech, many of the mega cap internet platform companies are actually quite attractively valued in our view. Facebook and Alphabet trade on a low 20s forward P/E multiple. Alibaba is on a high teens P/E multiple. We think these multiples represent good value for such highly profitable businesses. Another big industry within tech is semiconductors. This is a more cyclical industry but also has some secular characteristics these days.

We believe that demand will be strong over time because these companies are foundational to the increased technology demands of all industries.

Cameron Systermans, senior portfolio manager

Cameron Systermans

Technology stocks appear expensive relative to the broader market, but it is not easy to have conviction on whether technology will correct imminently. For the broader equity market, while it may be argued that developed markets, particularly the US, are expensive, on an equity risk premium basis, valuations are broadly in line with their long term averages given that bond yields are at record lows.

Price-sensitive investors who wish to gain access to technology may be able to do so indirectly through real estate, listed or unlisted. At present, listed real estate investment trusts (Reits) may provide a more attractive opportunity given that Reits have materially underperformed the broader equity market both in the selloff and the recovery. The Reit market includes allocations to data centres and logistics facilities, both of which are experiencing favourable structural and Covid-19 related trends.

Alternatively, investors simply seeking to navigate the challenges of the current market environment but fearing a style or sector rotation should embrace active management and ensure that their portfolio is diversified across a range of styles – notably growth, quality, value, momentum and size. Portfolios we manage with these characteristics have delivered positive alpha both in the selloff in the first quarter and the rebound in the second quarter.

Pamela Hegarty, portfolio manager and senior equity analyst
BNP Paribas Asset Management

Pam Hegarty

The technology sector has significantly outperformed the broader market on a year-to-date basis, and in some industries, like software, valuations are stretched for the highest growth companies. We, however, believe that the valuation of the technology sector as a whole is nowhere near bubble levels. 

Using data for the S&P 500 index, the technology sector is trading at a 1.13 times forward price-earnings ratio relative to the broader market, compared to a peak of 2.23 times during the internet bubble, and exactly in line with the 25-year median. What this means is that technology is trading at a 13% premium to the market, which is justified based on higher secular growth prospects and the strong overall profitability and cash flow of the sector. 

Although some technology stocks are very expensive, we are still able to find investment ideas in the sector by conducting detailed bottom-up research including valuation analysis that includes both long term discounted cash flow projections as well as multiples relative to history and to peers. 

Additionally, because digital transformation is impacting the entire economy, there are investment opportunities in other sectors that are tied to the themes of cloud computing, automation, artificial intelligence and the internet of things. We remain confident in the long-term durability of these secular growth themes.

Sundeep Gantori, equity analyst
UBS Global Wealth Management CIO

Sundeep Gantori

While tech valuations have risen, on a relative basis, tech stocks are trading in-line with the historical premium range of 15% to 25% (at the high end). Hence, we don’t think tech stocks are in bubble territory as Covid-19 has accelerated many long-term digital trends.

Within tech, while we like structural themes around digital transformation like enabling technologies or e-commerce, we see tactical opportunities in tech segments that are well-positioned for a cyclical recovery, These include fintech due to potential recovery in payment companies because of easing mobility restrictions, digital advertising due to stabilisation and likely cyclical recovery in discretionary and travel-related segments, and smartphones due to potential replacement cycle.

A likely acceleration in 5G mobile telecoms spending is another catalyst for the smartphone industry. We believe that valuations are relatively reasonable in the above consumer-related segments.

In the medium-term, investors need to pay attention to relative valuation measures like PEG (price-to-earnings/growth) or enterprise value/free cash flows rather than absolute PEs, given that the former metrics capture growth including cash flows, which are still in favour of tech companies currently.

Jing Cong Xue, equity analyst 
Foord Asset Management

Jing Cong Xue
Jing Cong Xue
The Covid-19 pandemic has accelerated the global push for digitalisation to the benefit of the tech sector. We like the sector generally but only invest when the valuations are attractive and the long-term investment thesis makes sense.
While the tech sector has experienced rapid valuation growth recently there are still pockets of value and some hidden gems. Semiconductor growth is a secular trend that should endure for the next decade as the world undergoes a digital transformation with more devices becoming smart. 
Taiwan Semiconductor Manufacturing Company (TSMC) is the world’s leading semiconductor foundry and a stock that we like. TMSC’s chip manufacturing technology allows mobile telephone chips to process at faster speeds with less power. It is also effectively a monopoly in the manufacture of leading-edge process nodes, yet its stock trades at only about 13 times EV/Ebitda. In comparison, other toll operators such as Microsoft (around 20 times) and Visa (26 times) trade at much higher valuation multiples for similar long-term growth potential.

Tony Kim, portfolio manager

Tony Kim

We believe that the technology sector sitting near all-time highs is a reflection of how critical it has become to the functioning of various industries and the economy as a whole.

Over the long term, we believe that the trends of disruption and innovation across sectors can provide support for the technology sector to deliver this run of outperformance. The investment thesis for the companies in which we are investing is unimpeded by the medium-term effects of Covid-19, and many of these companies are in fact experiencing increased demand in the current environment.

We expect continued adoption of the digital transformation theme, particularly through cloud computing and increased data centre utilisation, as global enterprises continue to invest in the modernisation and digitalisation of their operations. Technology today enables record-levels of digital functionality, powered by vast amounts of silicon and computing power, and facilitated by innovative software.

Michael Solecki, chief investment officer, fundamental growth and core equity

State Street Global Advisors

Michael Solecki

While the valuations for the “safe haven” technology stocks are significantly elevated versus history we would note that the overall market is trading at a heightened valuation and technology companies have the growth to back up their current valuations.

In fact, we believe that for several years, the market has systematically underestimated the size of the total addressable markets of many of the public cloud vendors and thus growth expectations and multiples had not been appropriately valuing the opportunity. The recently raised estimates of these companies provide for many years of compounding growth and eventual stock price appreciation, even at heightened valuations.

It is critical to ensure this expected growth will be profitable in the long term (by analysing the long-term profitability of newly signed business), but even at high multiples, high-growth compounders can prove to be attractive investments. In technology, we remain focused on high quality technology stocks that have strong barriers to entry, thoughtful management teams and the ability to report out-sized growth over multiple years.

Finally, in an effort to manage our portfolio risk, we look to balance our overall technology exposure with high quality names in the semiconductor and hardware spaces, that have less demanding valuations. 

Sean Taylor, chief investment officer for Asia Pacific

Sean Taylor

After the rally in the market, there could be some correction and we will be a buyer in the weakness. In the medium term, we expect no alternative to equity markets. Low interest rates can only support elevated valuations for as long as earnings are expected to be resilient. High valuations in the technology sector make it more vulnerable when profits turn out to be less sustainable than thought.

This pandemic, however, has accelerated technology trends and highlighted the resilient earnings profile of the technology sector which make it extremely attractive. There are certain technologies in the area of online education, entertainment and food delivery, for example, which will result in permanent changes in demand dynamics going forward.

In the long-run, we are cautious of the earnings prospects, especially in the US companies which benefited from lower interest rates and tax rates over the last decades. The upcoming US-election may create some downside risks. There seems to be little political appetite for further tax cuts, instead, the Democrats are looking to increase taxes.  

Besides IT, we also favour healthcare as a safe haven hedge in case of a second wave of the virus. 

Jaycee Man contributed to this article.

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