Tech stocks are in fashion

Day 24.07.2020 * Reading time: 10min.

 
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                                                                 Tech stocks are in fashion

 

In the past, tech stocks were not considered defensive investments. As the virus crisis has strengthened the fundamental role of technology in our lives, investors are looking to reduce risk and secure growth potential in companies, that have become digital tools to create global networks. Global technology companies are popular this year. The MSCI World Technology index rose by 10.3% this year until June 5, while the MSCI All Country World index fell by 3.9%. Industry trends and opportunities extend far beyond the well-known FAANG stocks.

Reliability supports sustainable growth

People expect technology to provide reliability similar to that of a water or electricity supplier. Operational stability expectations underpin recurring revenue streams that help support returns in difficult market conditions. These are the same dynamics that utility companies have provided to investors. At the same time, as many applications of the technology are new, investors can also benefit from sustainable growth trends. However, not all tech companies are the same. So in order to capture the long-term return potential in the sector, investors should look for companies that enable a technological revolution or strengthen digital transformation, in areas such as:

Payment systems:

In a world of social distancing, cash is no longer the king. For example, companies like PayPal and Adyen will be at the center of explosive growth in e-commerce and the increasing use of contactless payment systems – even in physical stores. Of course, the technological transformation in these areas took place long before the current crisis. The virus has accelerated the changes that should result in increased demand for many products and services across the sector. Innovative firms driving these changes – which are often not included in the benchmark – should, in our opinion, enjoy price power, even in difficult macroeconomic conditions.

Automation technologies:

With the redesign of global supply chains and companies considering shifting capabilities back to developed markets, automation technologies will be critical. Automation companies strive to support efficient and reliable production capacities and provide greater flexibility in the cost structure. The Internet of Things will become a key automation feature as 5G grows. In addition to unmanned factories and warehouses, we will also see more human-robot collaboration, enhanced by companies with assistive technologies such as Keyence, Teradyne and IPG Photonics.

Cloud infrastructure:

With remote companies and the increased demand for services, ranging from distance learning to medicine, cloud computing has become an even more important component of infrastructure. Companies that keep the cloud running smoothly or deliver innovative cloud-based applications are well prepared for a changing environment. Examples include Twilio, a cloud communication platform software provider that helps companies increase digital customer engagement, and Ciena, an optical systems provider that helps provide critical components to the upcoming 5G network deployment, and improves connectivity and speed in data centers.

The technology companies sector is ahead of the competition

Profits were stable across the sector. Global tech equities saw significantly higher profits and revenue growth than the broad market in the pre-crisis quarter. Since the outbreak of the pandemic, the gap has widened. Global tech companies are expected to achieve 2% revenue growth this year, as will defensive sectors such as healthcare and consumer staples, according to estimates, while industry profits will increase 3.9%, while mostly sectors, double-digit declines may occur. Even if we mitigate some of the dramatic effects of the pandemic by looking at the compound annual growth rate 2019-2021, tech sector earnings and revenue growth are expected to outperform the rest of the market by 9.5% and 3.8% respectively. Technology has entered a new role as a tool that consumers and businesses cannot live without. Many people turn on their smartphones first in the morning and turn them off just before going to bed. Broadband services, mobility, internet delivery, and video streaming are essential services today. These needs have become even greater as the pandemic has increased the need for remote shopping, study and work. Technology is more than ever essential for businesses and other businesses. Without a solid digital infrastructure, businesses cannot operate effectively from home work, and students will not be able to access online classes. Government institutions and healthcare organizations rely on technology platforms to convey information massively to the public. Employees and customers expect hermetic cyber security. Invoicing and payment systems must function seamlessly in the world of remote business operations.

Innovation leaders ensure stability and growth

These technical leaders are not necessarily cheap. Global technology equities are trading at a price/ earnings ratio of 21.9, which is a 26% premium over the MSCI ACWI 17.3 ratio. It’s worth paying more for select companies that offer innovative technologies that foster sustainable growth, especially in today’s low growth environment with significant uncertainty over the path to recovery. Investing in technology requires specialized skills. As technological innovation lowers entry barriers, traders need a deep understanding of changing trends to select winners. Investors jumped into the tech trend due to recent results may not have the experience to distinguish pioneers with enduring business models from companies in short-term euphoria. Discovering the technology inventory for the post-virus world requires a strategic focus on the changing business dynamics driving the demand for tomorrow’s services. With the right approach, investors can find tech companies that resemble defensive utilities – that support profits in weaker markets – but are also rooted in innovation that drives growth for better times.

One but …

Growth stocks are at historical price highs relative to value stocks. Value stocks are deeply discounted. MSCI World Value is 58% cheaper than MSCI World Growth, based on a combination of three value metrics: price/sale, price/cash flow, and price/profit. This is almost the biggest discount in 20 years. In the US, the Russell 1000 Value trades at a 56% discount to its growth stock counterpart – also close to historically low levels. For US small and mid-cap companies, the value-to-growth discount is even greater.

Chart: Trading in value stocks is executed at an exceptionally large discount in relation to the growth stocks

Global Stocks: MSCI Value vs MSCI Growth

US Stocks: Russel 1000 Value vs Russel 1000 Growth

(% discount)

Historical analysis does not guarantee future results. As of May 31, 2020
Valuation discount based on average price-to-sale, price-to-cash flow and price-to-forward ratios. For global equities, valuation discount and monthly percentile rank measured from May 31, 2000 to May 31, 2020. For US equities, valuation discount and monthly percentile steps measured from November 30, 1998 to May 31, 2020
Source: FactSet MSCI, Russell Investments

Rafal Ciepielski

Rafal Ciepielski

CEO RCieSolution

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The views expressed in this document are not research, investment or commercial advice, and do not necessarily reflect the views of all management teams. They change over time.