Thanks to new technology, we have achieved more in the last 250 years than we did in previous millennia.
This exponential potential for change has made technology stocks very popular.
For instance, in 2020, US tech stocks alone become more valuable by market cap than the entire European market.
Tech stocks are any company involved in the technology sector, from semiconductor producers to software providers. They are often a leading indicator for the economy and the stock market.
But what are the key characteristics of tech stocks and what should you consider when contemplating investing in tech stocks?
We can appreciate the popularity of tech stocks by, for example, checking the performance of the world’s biggest tech sector – the one in the United States, home to the Silicon Valley.
Take the NYSE FANG+ Index, for instance.
It is an equal-dollar weighted index representing a segment of the tech sector and consisting of highly traded stocks like Facebook, Apple, Amazon, Netflix, and Google.
Over five years to June 2021, the Index gained 255%.
In comparison, the blue chip index S&P 500 Index is up 104% in the same period.
What about the Australian context?
The S&P/ASX All Technology Index (XTX) features Australia’s leading and emerging technology companies.
XTX was launched in February 2020 to offer investors direct access to ASX’s fastest growing sector.
Since its inception, it has gained 65%. In comparison, the benchmark S&P/ASX 200 gained 15% in the same period.
Why should you consider ASX tech stocks? Here are a few reasons .
The ASX is one of world’s fastest-growing exchanges for tech.
For instance, technology was the fastest-growing sector on the ASX by new listings over five years to December 2019.
And technology was the top sector for IPOs on the ASX in 2019.
The ASX had 107 tech IPOs over FY2016-20, behind only the Japan Exchange and NASDAQ by volume, according to data from Dealogic.
Almost one in ten ASX-listed stocks is a tech company now.
The tech sector is defined by disruption and innovation.
Stocks with a dominant market position could see that market share erode quickly with the introduction of new technology or a disruptive up-start.
So, history and a tech stock’s track record should be evaluated with caution.
Future success is less certain in disrupted markets. Filtering by strong past performance may not pick up unheralded companies or the next generation of winners.
That said, here are some of the most successful ASX tech stocks by market size. The S&P/ASX Australian Technology ETF has half its weighting in these five stocks alone:
Some of these stocks also comprise the Australian equivalent of America’s FAANG stocks (Facebook, Apple, Amazon, Netflix, and Google).
The ASX version is abbreviated as WAAAX and includes WiseTech Global, Afterpay, Appen, Altium, and Xero.
In the introduction, I mentioned that advancing technology has aided us in achieving far more in a few centuries than we’ve been able to achieve in millennia.
Since the 1800s, we’ve been introduced to railway locomotion, the telegraph, the telephone, the internal combustion engine, electricity, radio, air travel, rocketry, space flight, nuclear power, the Internet, personal computing, and artificial intelligence.
This is not to downplay the importance of technological advancements prior to 1800 such as the printing press, the steam engine, or the compass.
But a steamboat is no space rocket and a compass is no Google Maps.
That is why tech stocks are attractive. Many believe there’s a real chance technological advances over the next 20 to 50 years could surpass much of what we’ve achieved since the Industrial Revolution.
Technology stocks are popular because many see them as socially transformative.
How many of us haven’t purchased something on Amazon and skipped the hassle of driving to the shopping centre?
How many of us haven’t ditched the usual TV programming to watch something on Netflix?
And how many of us still consult dusty encyclopedias to look up facts or flip through a street directory to find directions?
Tech stocks like Google and Amazon have changed our habits while engrained themselves in new ones.
This ability to seem integral to our daily lives makes tech stocks attractive investments.
So, if you are considering investing in ASX tech stocks, we have some great guides to get you started.
These have been perennial open questions among analysts and investment gurus, with entrenched camps on both sides.
According to a 2021 Deutsche Bank survey of 627 market professionals, US tech stocks were seen as the second largest bubble after Bitcoin, with 83% of respondents giving US tech stocks a bubble rating of 7 or higher (out of 10).
There is also the rising euphoria in the market, as measured by investment bank Citigroup’s Panic/Euphoria Index. According to the index, at the start of 2021, euphoria was its highest on record.
But it is also true that tech firms, as valuation guru Aswath Damodaran said, command much higher multiples of earnings and revenues than other firms, the difference usually attributed to their higher growth potential.
A possible reason the debate over the value of technology stocks is so heated lies with the perceived inadequacies of traditional valuation metrics.
After all, a true bubble requires price in gross excess of value. But how do we know if the tech sector is overvalued or not when many tech companies don’t operate on traditional business and sales models?
The analytical landscape has changed quite a lot since Graham and Dodd’s old-school treatment of investing in their seminal Security Analysis.
A P/E ratio isn’t that useful when an emerging tech stock is yet to have any positive earnings, funnelling all its money to expansion and R&D.
As Burton Malkiel wrote in the popular A Random Walk Down Wall Street:
‘Security analysts began to use a variety of “new metrics” that could be used to value the stocks. After all, the New Economy stocks were a breed apart – they should certainly not be held to the fuddy-duddy old-fashioned standards that had been used to value traditional old economy companies.
And so valuation criteria such as price to earnings, price to book value, or even price to sales were abandoned in favour of a whole new set of valuation metrics.
Unconventional methods of valuation seemed appropriate to the cutting-edge, New Economy companies that were promising to revolutionise the way we communicated, went to school, shopped, invested, and received our news and entertainment.’
The occasional difficulty in applying traditional metrics to tech stocks can lead us astray. We only need to cast our minds back to the dot com bubble.
But the likes of Amazon, Google, and Apple survived the crash and have continued to grow and post impressive earnings year after year.
So, what’s the takeaway?
Being a tech stock is no guarantee in itself that the stock is a sound investment.
You must assess the stock’s technological offering and the impact it is slated to have on society or the market.
Further, tech stocks are still – despite the frequent sci-fi gloss – businesses at the end of the day. So you have to consider how a company’s innovation translates to sales and sales to profitability.
Following developments in the tech sector can be a dizzying business.
Given the prominence and popularity of the sector, there is plenty of news coverage and tech firms vying for our attention.
As the Australian stock market frequently shadows moves made in the US stock market, you can often anticipate the performance of the ASX tech sector by seeing how the tech-heavy Nasdaq is performing.
Finally, since technology stocks are focused on innovation, it’s not necessarily about what they are doing today but what they going to do tomorrow.
Therefore, catching up on day-to-day updates may not be as productive as thinking about the technological trends and shifts set to define our lives.
That’s why it can pay to keep track of megatrends.
Think of a megatrend as a force that defines the world today and that of tomorrow.
A megatrend is far-reaching and involves shifting global patterns of behaviour and environment.
The increasing complexity and advancement of technology are making megatrends more frequent and the companies seeking to leverage them.
What are some current developments flowing from these megatrends?
Well, we have things like the electric vehicle uptake, blockchain technology, supercomputing and quantum computing, advancements in battery technology, artificial intelligence, and the Internet of Things.
So while we all can’t resist checking what the Nasdaq or the ASX Tech Index is doing on any given day, we can also channel some of that energy into thinking about industries and stocks which can stand to benefit from emerging megatrends.
Global investment manager BlackRock listed 5 megatrends it believes are shaping our future:
We’re at the VR train and ready to get on board. Now here’s the thing, we’re actually early to the VR train this time as well, from an investment perspective. The idea of VR and the technology isn’t new. I’d still classify it as revolutionary, but it’s not new.
By Sam Volkering,
Investment ideas from the edge of the bell curve.
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