Growing prospects in technology stocks
Digital transformation and AI are major driving factors
DESPITE the strong gains in recent years, and the recent robust rebound in United States technology stocks, valuations of many companies remain fair, says a fund manager.
And while there will be continued volatility in the market in the near term, the share prices of technology companies have the potential to move even higher in the medium to longer term. This will be in tandem with their growth prospects, as technology continues to advance and evolve at an incredible pace, explains Stephen Jue, co-portfolio manager and senior research analyst for US technology at Allianz Global Investors.
“There are pockets of stocks that are expensive, but in general, valuations of most technology companies remain reasonable relative to growth,” Jue argues.
“We expect to see (an upward) rerating of many technology stocks because of the acceleration in digital transformation and growing adoption of artificial intelligence (AI),” he said during a webinar panel discussion on “Technology and Artificial Intelligence – Investing in the New Norm or into the Future?” yesterday.
The webinar was organised by RHB Asset Management.
At present, the S&P 500 Information Technology (IT) sector is trading at around 24 times the current price-earnings (P/E) and 21 times the forward P/E.
The benchmark S&P 500 Index, on the other hand, is trading at 23 times the current P/E and 18 times the forward P/E.
Jue notes the S&P 500 IT sector’s P/E ratio based on the estimated 2020 earnings is temporarily high due to the Covid-19 pandemic, which has negatively impacted businesses worldwide. He says the valuation of the sector will start to normalise next year as earnings recover.
Dotcom bubble experience
The S&P 500 IT Index has rebounded about 49% from its March low during the height of the Covid-19 fear early this year. In the last one year, the index has gained about 33%.
This compares with the S&P 500 Index, which has gained 40% from its March low, and only 6.6% over the last one year.
Jue points out that the technology sector outperformance in recent years has been mainly driven by the FANG (US tech giants Facebook, Amazon, Netflix and Google) and the BAT (China tech titans Baidu, Alibaba, and Tencent).
In general, the sector has been very much consumer and mobile Internet-driven over the last few years.
Jue notes each wave of technology disruption can create new winners over the next three to five years.
Dismissing concerns that the recent technology trends could be similar to the experience of the dotcom bubble of the late 1990s, Jue highlights some pertinent differences.
He notes during the tech bubble, tech valuations were not rational, and they were not not supported by sustainable growth and profits.
Before the tech bubble burst in 2001, the S&P 500 IT Index were traded at a wide range of between 30 and 80 times P/E.
Today, Jue says, tech valuations are far more reasonable, and tech companies now are also producing tangible earnings and cash flows.
“During the Dotcom Bubble, tech companies had unproven business models. But we have bigger (tech) companies now and their business models are mode credible relative to the Dotcom days,” Jue explains.
Technology race
The race to take leadership in advanced technologies, such as the fifth generation technology standard for cellular networks (5G), could determine the future balance of geopolitical power.
This, Jue says, is likely to pull forward commercialisation in many areas, as nations look to get an edge in tech supremacy and future economic growth.
This will benefit the development of AI; next-generation infrastructure such as 6G or 7G; autonomous solutions; and quantum computing.
Jue says AI or machine intelligence will continue to make to progress and it is expected to approach human intelligence in the next 10-15 years.
AI could contribute up to US$15.7 trillion to global economy in 2030. This is more than the current gross domestic product values of China and India combined, he points out.
Investment themes
According to RHB Asset Management Singapore chief investment officer Tan Jee Toon, many companies have already been impacted by AI, and many are investible companies.
He notes the Covid-19 pandemic will eventually pass. Future winners will be those that are able to take advantage of the “new normal”.
With the advancement of technologies affecting the way we work, live and play, Tan reveals, his 12 key investment themes as infrastructure, 5G, bandwidth, computer equipment, cloud computing, healthcare, e-commerce, online supermarket, online delivery, online gaming, online education, and online entertainment
He notes 34 of the Top 50 smartest companies in the world come from China, while 12 are from the United States. From China, these include Huawei, Ping An, Alibaba, Baidu and Tencent, while from the United States, these include Tesla, Johnson & Johnson, Qualcomm and Intel.
Local opportunities
Meanwhile, in the local equity market, Aminvestment Bank Research (Aminvest) has upgraded its outlook on the technology sector to “overweight” from “neutral”, citing attractive valuations with expected recovery in the second half of 2020.
The brokerage points out that the sector’s outlook remains resilient despite the companies’ operations being impacted by the partial and/or complete nationwide lockdowns and travel restrictions worldwide to curb the spread of the Covid-19 virus.
“As the automotive and industrial segments have been hit harder by Covid-19, we expect the focus to be on the telecommunications segment with the 5G growth upswing; growth in smart sensors with applications in telecommunications and automotive segments; and the adoption of Industry 4.0 technologies such as AI, Internet of things (IOT) and automation to rapidly increase production when economies recover,” Aminvest argues.
Citing projections by the World Semiconductor Trade Statistics (WSTS), Aminvest expects the global semiconductor market to register growth of 3%-6% in the next two years.
In its May 2020 forecast, the WSTS says the market could grow 3.3% to Us$46bil this year, driven by the Americas and Asia Pacific. By product segments, it expects a 5% growth in integrated circuits (ICS) where all categories memory, logic and micro are expected to recover, except analog ICS. Discrete semiconductors, optoelectronics and sensors, on the other hand, are predicted to see declines of 6.6%, 5.1% and 2.1%, respectively.
For 2021, the WSTS projects a 6.2% growth across all geographical regions and product categories.
Its top pick in the sector is Inari Amertron Bhd, rated buy with a fair value of RM2.01. The brokerage is positive on the company due to good prospects arising from the resilience of its radio-frequency device earnings, thanks to higher chip complexity in 5G phones; potential growth in laser devices from more biometric and AR (augmented reality) applications; and the longer-term growth in LED riding, on higher demand of high-resolution shopping mall billboards.
Nevertheless, there are still downside risks facing the local technology sector.
The brokerage notes these risk include weak economic conditions brought on by a resurgence of Covid-19 cases globally that could cause a lukewarm demand for end products; monotonous content growth in underlying products in the absence of innovation; margin erosion in the face of a weakening US dollar; and worsening trade war between the US and China, especially in relation to technology and intellectual property. These are risks that could result in Aminvest downgrading the sector to neutral or underweight.