Technological megatrends promise growth even in turbulent times. According to DNB, the prices of tech stocks are expected to increase by eight to ten per cent in 2016. The odds can even be improved by targeted stock picking. Particular names such as SAP and Oracle are especially well positioned in the race for the top returns.
The beginning of the new year has not been kind to technology stocks. Since the beginning of the year, the technology-laden Nasdaq Composite Index has declined by approximately ten per cent. This has, however, had a positive side effect: in the process of correction, the valuations have returned to their historical averages. Right now, technology stocks are being traded with a price–earnings ratio of 16. This puts the technology sector right in the middle when compared to other sectors. ‘If you take a look at the growth outlook and the significant cash flows of the established players, the valuation is very fair,’ says Anders Tandberg-Johansen, manager of the DNB Technology fund. The high level of cash flows should also serve to entice investors. For 2016, Tandberg-Johansen predicts a profitable stock year – albeit a volatile one. Ultimately, he is expecting growth of eight to ten per cent for technology stocks.
These returns can be made even higher through targeted stock picking. By implementing targeted stock picking, the DNB Technology fund was able to achieve returns of 14 per cent per year over the past five years, thus making it the top performer of all global TMT funds.
In order to optimise the selection of stocks in the enormous world of technology, the DNB team identified six technological megatrends. These trends provide high growth rates over the long term – and largely independent of fluctuations in the market. To put it concretely, the megatrends are the growth of the Internet (especially in the emerging markets); the connectivity between objects and the Internet (the so-called Internet of Things); the fragmentation of television across services such as Netflix, Apple TV and Amazon; the digitisation of financial services (so-called fintech); cybersecurity; and cloud computing.
‘The time when there were still discussions about whether more and more data and services would be moved to the data cloud is over. Cloud computing is happening at the moment. Now the talk is about who the winners and losers are in the cloud computing trend,’ says Mikko Ripatti, senior portfolio manager at DNB. DNB counts Oracle and SAP among the winners. These traditional IT companies are excellently positioned in this trend. In addition, they stand out thanks to their profitability, great innovative strength and low valuations. For example, Oracle is being traded with a price–earnings ratio of 12.
The high valuations are, however, one reason why DNB is not currently invested in the cybersecurity megatrend. But cybersecurity remains a very interesting area of business. More and more sensitive information is making its way onto the Internet. Facebook alone has 1.5 billion registered users, and 1.4 billion people use Android. Companies and government agencies are storing data externally as well. ‘The growth potential is huge, but the valuations are too high at the moment and we are very disciplined in our approach,’ says Ripatti.
The DNB tech team’s investment approach emphasizes reasonable valuation combined with cash generation capabilities. Trends are important, but the idea is not to go chasing them at any cost. This focus on profitability has permeated the entire IT industry. While a mere 50 per cent of technology companies made profits during the dot-com bubble, this number now currently lies at 90 per cent. What is more, the tech giants are hoarding large amounts of cash. Apple, Google and Facebook have set aside 140 billion, 70 billion and 20 billion dollars respectively in cash.
The technology sector’s disruptive power makes is it especially attractive. Digitization and new technologies are transforming entire industries. As we speak, the technological transformation is making its way into the financial sector. Antony Jenkins, former CEO of Barclays, has already predicted an ‘Uber’ moment for the financial sector. With its disruptive service, Uber has put the taxi industry under significant pressure. In the area of fintech, however, it isn’t a few large players that are mixing up traditional structures, but rather a number of smaller ones. More than a thousand companies are active in the fintech sector. ‘There is also a lot going on. The small companies are proving themselves in specific segments with advanced technology,’ says DNB expert Ripatti.
The world of media is in full-on transformation. Norwegian children already spend more time on the Internet than watching television. In the United States, YouTube is the most watched network. ‘The consumer can not only decide which content to watch, but also when, where and on which device they see it. Those are the killer applications,’ says Ripatti. Netflix and Amazon Prime are the biggest providers. They are benefiting from the current trend of fragmentation of the television industry.
Alphabet, the holding which owns not only YouTube but also Google, is particularly well positioned as regards most trends. This fact, along with the valuation at a reasonable level, helps put the search engine giant into the technology depot of DNB. DNB sees regulation as the greatest risk for the company – the European Union represents the greatest threat of resistance.
The technology industry is not only turning traditional industries inside out, but it is also transforming itself. Recently, Alphabet briefly replaced Apple as the most valuable publicly traded company. The manufacturer of the iPhone fell flat among investors in the previous year. Within one year, the stock price fell by nearly 30 per cent. Despite the apparent saturation of the smartphone market and Apple’s high degree dependence on iPhones (two-thirds of its turnover), the company stands out thanks to its strong brand, high cash reserves and especially high economies of scale.
