Sky-high valuations on companies that have yet to make a profit remind the manager of the last tech boom and bust. However, O’Gorman also notes that the macro-economic pattern also seems to be repeating itself: the world is unwinding a huge overweight to emerging market economies and shifting that cash into racy growth areas such as early-stage internet tech.
“The similarities with the last time are quite striking,” he said. “When this happened before, we had had a major wobble in Asia, an Asian currency crisis, there was a big shortage of growth except for this little thing called tech which was very exciting and going to change the world.”
“There was a ton of money thanks to central bank largesse and valuations got ramped up, got so expensive we had to invent new ways of valuing things, such as 'price to eyeball'.”
O’Gorman warned last year of the astounding valuations on early-stage tech stocks which he said were unreasonable and likely to end in pain.
He admits that the crash hasn’t happened yet, but notes that the valuations are even more extended than they were.
Software company Tableau, which was trading on 592 times earnings, is now on 722 times, while IT data analyser Splunk has moved from 284 times to 355 times.
“This worries me as a lot of these companies compete with each other and they compete with a lot of large companies and new start-ups with backers with deep pockets,” he said.
“The advantage is they don’t have any earnings so they don’t have earnings targets to miss,” he added.
“They are always selling good products at a loss, which means it’s pretty easy to grow sales, so they are getting a lot of credit [from the market].”
“Most have continued to have negative earnings, selling even more at big losses. It’s hard to understand the valuations,” he added.
One UK internet stock that has grown without making a profit is Ocado, which has gained a striking 393.16 per cent over the past year.
Performance of stock vs index over 1yr
Source: FE Analytics
The company is riding high on the back of a deal to distribute Morrisons goods, but figures reported today showed losses have widened and the company still hasn’t made a profit. Shares sold off 4 per cent on the news.
One of the attractions of tech stocks to the average UK investor is that they sell into the developed markets rather than the stuttering developing world.
This means they are a prime target for investors looking for growth and fleeing the moribund emerging market regions.
“Financially these guys are very developed market-centric and don’t really have sales in emerging markets,” O’Gorman said. “Optically it looks like they are growing because of their geographic exposure.”
Emerging markets have struggled relative to developed markets over the past three years, and the trend has continued into 2014.
Performance of indices in 2014
Source: FE Analytics
O’Gorman says he has long predicted this would happen as a consequence of the quantitative easing programmes implemented in the US and UK. He expects this trend to continue in the near future, and says the only solution is likely to be more coordinated central bank action, which means more QE.
This will mean a continuing wave of money seeking growth areas such as tech.
“There probably needs to be some sort of intervention. This is the danger in being too short: the drug addict economy will get another fix from its drug dealers in the central banks,” he said.
“I think we are going to see China sell off when it opens after the Chinese New Year,” he added.
“I still think the world is overweight emerging markets, certainly Europe and the UK are overweight emerging markets when you look at the size of the funds, and they are overweight commodities and underweight tech as a result.”
The manager says that he expects technology as a whole to outperform in the short-term. While small cap tech looks like it is in bubble territory, overall the sector looks cheap compared with history.
“Valuations on technology over time look very cheap. It is one of the few areas where world valuations are towards the low end of where they have been for the last 20 years,” he said.
“Technology has continued to outperform non-tech and I still think this is going to continue no matter what the direction of equity markets is,” he added.
“I have some worries in the mid- to long-term, but over the next 12 months I still feel reasonably confident about that.”
O’Gorman also notes that the sector has the best record for free cash generation, which means more of a cushion on the downside.
He says that large cap tech looks cheap, and the fund’s relative weighting to this area is why he underperformed his peer group last year for the first time in a decade.
However, the problem in this part of the market is emerging markets, and the manager notes that his cash position has been rising. It is now at 7 per cent.
“Large caps are more exposed to emerging markets, which means it’s going to be hard to beat earnings so it’s not the time to lurch large cap,” he said.
“We are finding a lot more stocks hitting our price targets and it’s harder to find value in the market.”
“There are lots of great stocks and companies but you are getting there as far as valuations are concerned. We are seeing more pricing pressure in our areas.”
The manager says that there is more aggressive pricing in tech sectors now, with more companies willing to sell at a loss to take market share. Investors in the sector need to keep an eye on this, he warns, and on valuations in the punchier small cap areas.
“The danger is these things keep going up and up,” he said. “I am not really willing to play this. If you want those exciting fun companies that will grow for ever, this is probably not the fund for you.”
“The danger is these things continue to worsen and there’s the chance we are entering another bubble.”
O’Gorman has run the £391m Henderson Global Technology fund since 2001, witnessing the dotcom crash at first hand.
The fund has made 130.66 per cent over the past 10 years against returns of 90.07 per cent from its MSCI Information Technology benchmark. It has ongoing charges of 1.82 per cent.
