Tech: here for the long term

clock • 4 min read

Technology isn't all volatile start-ups or new gadgets. It's a sector whose prospects make it an attractive investment for the long run.    

Lyft and Uber IPOs have dominated tech sector headlines, with investors first snapping up shares in the car-sharing firms only to dump them weeks or even days later. Such a quick turnaround in sentiment is clearly unsettling. But it is not indicative of the tech sector as a whole. In fact, tech stocks are up over 15 per cent since the start of the year, the strongest performance of all the sectors.


Source: Pictet Asset Management, Bloomberg

That's in part because the sector benefits from long-term structural trends: technology's role in our lives is growing by the day. For investors willing to take a longer term view - and ignore the market noise - the potential rewards are attractive. 

Compared to the boom of the late 1990s, the companies in the tech sector today are in a different league when it comes to their fundamentals. 

To begin with, tech firms are profitable, with room for manoeuvre should times get tough. These days, the median US tech company has a free cash flow (FCF) of USD349 million compared to just USD46 million two decades ago. And the sector now contributes nearly a fifth of S&P 500's earnings, up from 10.3 per cent in 1998.

Secondly, while valuations are, undoubtedly, less attractive on average than they were a year or two ago, they are still a long way off the ultra-stretched levels seen in the run-up to the bubble. 

According to our calculations, US software companies, for example, are more attractively priced now on every major metric than they were in 1999. Such stocks' price to free cash flow ratio now is less than half what it was then, while the dividend yield is three times higher (see Fig. 1).

What also distinguishes tech today from tech in the 1990s, is that its influence spans virtually every industry sector, engaging businesses and consumers alike.

Take artificial intelligence, for example. Google is working with AI, through DeepMind and RankBrain machine learning systems, to improve its search engine. Amazon uses AI to learn about your shopping preferences and predict your most likely purchases, as well as for Alexa. Microsoft's personal assistant Cortana can help predict business outcomes - such as demand for your product - based on machine learning. Facebook's investment in AI includes natural language processing, real-time analysis of news feeds and facial verification software that is able to identify people in pictures with over 97 per cent accuracy.

By 2030, AI is expected to have boosted world GDP by 14 per cent - or some $15.7trn.


AI's forecast contribution to world economic growth in 2030

* Developed Asia includes Japan, South Korea, Taiwan and Singapore. Rest of the world includes Africa, Oceania and rest of Asia.
Source: PWC, "Global artificial intelligence study: sizing the prize", 2017

To accommodate this, the world needs more data storage, tougher digital security and faster networks. Cloud computing is evolving to meet the challenges of exponential data collection on a pay-what-you-use basis. Revenues in the sector are set to grow five-fold from 2017-2022 to $331bn, according to research consultancy Gartner. We believe that is just the beginning: there is  potential for spending on cloud technology to grow ten-fold from current levels.

When it comes to networking, 5G can help improve wireless network speeds by a factor of 10, whilst reducing delays (latency). Crucially, this technology is designed with AI in mind, which means it is capable of collecting exponential amounts of data.  The US is taking the lead, with telecom equipment firm Verizon expected to have 30 cities connected by the end of the year. Gradual rollouts are also underway in Japan, Korea and China and 5G is expected to be globally widespread by 2025 according to Bank of America Merrill Lynch. 

Increased digital security, meanwhile, can come from blockchain. The cryptocurrency bubble may have burst, but for blockchain that's arguably been good news, pushing the technology more towards real world applications. Its ability to fragment data and keep it private has applications everywhere from banking and online shopping to human resources and logistics. By 2030, blockchain will create USD3.1 trillion in business value.

Of course, every industry and every investment comes with its own risks, and tech is no exception. The two main threats come from regulation - as US and European governments crack down on cyber security - as well as from the global trade war. It is important to be cognisant of these risks, but they can also create pricing anomalies and thus attractive investment opportunities, particularly as some tech stocks are more likely to be impacted than others.

Overall, the tech sector is now much more diverse and more profitable than it was two decades ago. The long-term opportunity is as attractive as ever, while the broad sector's ability to withstand any potential bouts of volatility is much stronger than it was during the bubble.

Anjali Bastianpillai, senior product pecialist - Thematic Equities at Pictet Asset Management