Time to Invest in Tech Stocks

Investors have been extremely averse to buying back into the tech sector after getting burned in the wake of the technology bubble bursting back in 2000-2002. Although prices have rebounded since then, shares in this sector have, in general, failed to generate excitement. With the exception of crowd-pleasers such as Google (GOOG) and Apple (AAPL), technology shares have essentially “missed” this cycle and have performed roughly in line with the broad market. However, the stars are beginning to re-align and technology shares may benefit from key emerging secular trends that will likely change the business landscape in the years to come. Indeed, several big name technology companies such as IBM (IBM), Texas Instruments (TXN), Hewlett-Packard (HPQ), Oracle (ORCL), and Cisco (CSCO) are on our “Strong buy” list, and are well-positioned to beat the market over a 3-12 month time horizon.



Inflation can be good for tech

The major theme for the next few years is the shift to an environment of accelerating price increases. As such, global growth will likely be sluggish as policymakers are forced to tighten policy to rein in potential runaway inflation. With a few notable exceptions (such as the energy and materials sectors), price increases present headwinds for companies as they eat into profit margins and earnings growth. One avenue that companies can take to cut costs is to invest in technology to enhance productivity, which is positive for tech because demand will likely increase as price pressures increase and firms run out of ways to trim expenses.


* Source: U.S. Census Bureau
** Source: U.S. Bureau of Labor Statistics
Note: “”LS” = Left Scale, “RS” = Right Scale

In addition, as energy prices continue to rise on the back of robust demand from emerging economies, travel will become more expensive. The airlines have certainly felt the brunt of the shock and are now cutting routes and downsizing their fleets in order to salvage what remains of their existence. As accessibility to flight will likely not be as pervasive as it has been in the past twenty years, one way to capitalize on this front is for firms to invest in networking and connectivity in order to facilitate working remotely and minimize travel-related expenses.

More connectivity… everywhere

In emerging economies, the robust trend in spending on infrastructure and capital goods will necessitate further investment in new technologies in order for the fruits of said investment to be reaped. At the consumer level, internet connectivity and mobile phone penetration remain low enough for a material expansion of demand.

In developed countries, the retirement of Baby Boomers is a huge factor as they will continue to be replaced by a younger, more connected demographic. Young people are typically more willing to try new gadgets and ways of communicating and there is a trend towards “hyper-connectivity” and personalized content. As such, firms will be more inclined to increase the adoption of new technologies given the shift in adaptability in the workforce.

Valuations reasonable

From a valuation perspective, technology shares are no longer extravagantly valued, and have appreciated in line with fundamentals this cycle. Still, it will be important to discriminate inside the sector as not all tech firms are created equally. Potential winners are those that have strong balance sheets (low debt and lots of cash), companies involved in networking and connectivity, such as Cisco, and niche players that offer personalized business or consumer services that will appeal to the growing demands of the younger generation that is entering the workforce.

To summarize, technology stocks will likely benefit from: Higher demand from firms as they try to cut costs; rising infrastructure and connectivity spending in emerging countries; and demographic shifts in developed countries. This is a long-term idea and may take some time to play out, so patience is warranted. Investors who wish to play the whole sector without picking stocks may want to play this theme via a technology ETF such as VGT or by buying the NASDAQ 100 ETF (QQQQ).

Disclosure: No positions at the time of writing.

Comments

[Respirate:]

You make some reasonable assumptions, Super Stock Screener, and technology may be a leader in equities going forward. Unfortunately, your graphs detract from your argument. Your top graph shows that technology capitalization as a share of the total markets already at or above the norm. It only looks lower compared to the 99-01 tech bubble from which many portfolios have still not fully recovered. The second graph shows only that the YoY PPI is negative and yes, it will probably revert to the mean, but not that it will necessarily add much to technology market capitalization. In the end your article overall contains only very general assumptions and adds nothing new.

Sep 17 06:43 AM

[Stez:]

You have IBM on your strong buy list.

But in an earlier article you had it on your list of over leveraged companies.

What has made you do an about turn, if you regard it too highly leveraged?

Sep 17 07:30 AM

[mollytjm:]

'hyper-connectivity' is the key to tech products for the future. And the ability to innovate quickly and well is the key to tech company life.
Of the companies you list, Apple is at the top for this. Employees are starting to ask for Apple products at work and companies are beginning to understand that with IT costs very high, easier to use, less problem prone technology can save them money as well as employee time.

Sep 17 10:42 AM

[Infinite loop:]

I invested heavily in Tech in March. Im already sitting on a very large profit.

When everyone's hair is on fire it's time to buy.

Sep 18 10:06 AM