Interactive Investor

The 'old' tech shares still worth buying

6th July 2017 13:57

Dzmitry Lipski from interactive investor

The technology sector has significantly outperformed global stockmarkets over one, three, five and 10 years, beating the MSCI World index every time. That's largely the result of strong contributions from the so-called FAANG stocks: Facebook, Amazon, Apple, Netflix and Google.

However, in June this year, the sector suffered a sell-off and Goldman Sachs expressed concerns that low volatility in these major stocks could impact their performance. While the FAANG gang has driven a big chunk of the sector's longer-term performance, it has at least been underpinned by robust growth and solid earnings.

Despite the recent dip in share prices, some investors remain concerned that another dot-com bubble is emerging. But this time round it could be argued that there is a far better macro backdrop and fundamentals supporting the sector.

Not the same "get large or get lost" sector

As one of the best performers over the last few years, the technology sector has grown significantly. It now accounts for 22% of the S&P 500 index, up from 15% in 2008, marking its heaviest weighting in the benchmark index since the tech bubble in 1999 at almost 30%. To support such a large weighting, it should be noted that tech's share of S&P 500 earnings is currently 24% compared to only 15% during the tech boom.

In terms of valuations, the current price/earnings (PE) ratio for the sector is 23.3, which is just above the S&P 500 at 21.5. In contrast, as shown in the chart, below these numbers diverged significantly back in early 2000.

Looking at the sector's composition, it has also changed compared to 2000. While it has historically been considered as a cyclical sector, it now includes a growing number of companies that could be seen as defensive in nature.

This could help explain the sector's impressive resilience. Tech can be divided into two: high growth disruptive companies such as Uber, Airbnb and Snap, and well-established global businesses such as Apple, Google-owner Alphabet, Amazon, eBay and Microsoft.

Those established names in the latter category have become increasingly like consumer staples as people are increasingly reliant on their products. They have strong balance sheets with large cash reserves, limited debt, and most are starting to pay dividends.

Mind your exposure

Some tech fund managers focus on the larger companies, employing a more benchmark aware approach. The larger, more mature or "old tech" companies with massive cash reserves are now capable of growing their dividends and reinvesting in the business. But they are also able to participate in the growth of new and emerging themes within the sector, by acquiring smaller or "new tech" companies at the cutting edge of relevant new technologies.

Manager Hyunho Sohn of Fidelity Global Technology (a Money Observer Rated Fund) is looking for quality companies globally that have, or will develop, products, processes or services that will provide or will benefit significantly from technological advances and improvements.

Stocks HyunHo favours tend to fall into three categories: growth, cyclical and special situations. The fund's top holdings include Alphabet, Intel, Apple, Salesforce.com, Yahoo and Qualcomm.

Other fund managers specifically target "new tech" smaller companies as they anticipate strong growth stemming from such companies' disruptive new technologies.

A good choice for long-term investors is another Money Observer Rated Fund Polar Capital Technology Trust, managed by Ben Rogoff. The trust offers exposure to the biggest players such as Alphabet, Microsoft, Facebook and Apple, together with some exciting emerging technology businesses with high growth prospects.

It is worth nothing that more benchmark aware funds could have a very large allocation to Apple given the company's dominant weighting in indices. For example, it currently accounts for 13% of the MSCI ACWI Information Technology index.

In addition, under the UCITS constraints fund managers are unable to hold a position size of more than 10% in any stock. This means if Apple performs strongly, a fund's performance will suffer in relative terms.

Investors looking for technology exposure should therefore take into account not only their specific objectives and attitude towards risk, but also the type of vehicle they are buying and, given its unique importance, their investment view of Apple.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.