A sector which looks poised to deliver strong capital growth – one that has been much maligned in the past – is technology. Traditionally, fast-growing technology companies have argued that it is better to reinvest profits into the business to drive growth rather than distribute them to investors via dividends.
Neil Campling, fund manager on the New Star Technology fund, points out that the sector is at a 10-year valuation low.
“Because of what happened at the start of the century companies are sitting on hoards of cash. We can see through the first quarter earnings season that technology firms have held up very well. Many technology companies now have stable business models delivering double digit growth.”
“It’s taken a long time for people to forgive what happened in technology, media and telecoms (TMT)," says Lindsay Whitelaw, manager of the Artemis New Enterprises fund. “In the last few years technology companies have moved forward. Valuations are generated on fundamentals and the hype has been knocked out of them.”
There are some key differences between today and the height of the TMT boom; valuations in the sector have compressed significantly, there is little of the excess and oversupply that contributed towards the bubble, and companies are not only smarter but have shored up their balance sheets and are in a position of strength.
Many technology stocks have been downgraded significantly, often without justification, meaning valuations look very attractive. Whitlelaw believes the impact of the TMT bubble could be viewed as positive in some respects. “If you look at valuations, we’re getting back to 2002/2003 levels. Growth expectations are much lower now and tech is certainly not susceptible to hype. We’re seeing a lot of pretty strong recurring revenue streams and there’s a degree of resilience not reflected in share prices.”
“Technology companies don’t have debt,” says Stuart O’Gorman, manager of the Henderson Global Technology fund. “A lot of cash has been used for acquisitions, but there’s still a huge cash pile and they are immensely cash generative.”
He also highlights the increased amount of capacity and reduced competition.
“It seems that Oracle has bought up half the US market, and IBM and Hewlett Packard are joining in on the feeding frenzy, and are paying cash. We’re seeing a pricing environment in a lot of areas which is a bit more rational. There’s been a dramatic effect on margins over the last couple of years. Technology does have these secular drivers. There’s still the fundamental innovation that allows the costs to come down and functionality to be delivered.”
O’Gorman points out that technologies promised during the TMT bubble, such as mobile data, are finally coming to fruition.
“Look at the iPhone. And dongles are even more exciting. We will reach a tipping point where people will no longer need a BT landline. A key theme we’re playing is mobile broadband.”
“Technology is a cyclical sector that comes in and out of favour so you have to take a medium to long-term view,” says Whitelaw.
“You should never put more than, say, 5% of your portfolio in tech but now is an interesting time.”
2 June 2008