Here is a slightly outlandish idea. If you are looking for safety in these hard and uncertain times, buy tech stocks.
I realise this contrarian advice comes at a peculiar moment, what with Facebook having landed on the US markets at a truly astonishing valuation. But the social media giant is not representative of the much broader technology sector. That vast, largely US-based leviathan, has rebounded impressively since the dark days of late 2007. The DJ World Technology sector is up 32% compared to 0% for the FTSE World, excluding dividends, and is currently my favourite ‘quality’ sector.
Mainstream investors wax lyrical about the defensive appeal of, say, pharma or tobacco but I cannot help thinking there are some major clouds on the horizon in both sectors, plus a lot of very stock-specific risk.
The case in favour of investing in technology seems much clearer to me – it has the potential for sustained organic growth, yet also boasts share prices at relative lows.
The case for growth over the medium to long term is simple to see and built on a couple of observations.
Why investors should target tech stocks
The first is the technology buying cycle currently favours the tech sector with a huge wave of capex expenditure underway to reboot corporate infrastructures. This short to medium-term cycle crosses over with a more profound long-term shift to distributed computing (aka the cloud).
Obviously there is the need to add the usual cautions at this point. Do I think these structural shifts will withstand a Greek-inspired Armageddon? Of course not. But technology is likely to be a beneficiary of any move by the huge corporates to start spending the vast amounts of cash on the balance sheet.
Given a choice between hiring more workers, building new factories in France or spending it on productivity-enhancing technology, guess what most corporates will do?
All this longer-term enthusiasm is fine but it should not power an immediate investment decision – for many investors no amount of wonderful growth in the future is worth paying a ridiculous amount of money in the here and now.
The share-price multiples at outfits like Amazon and Facebook certainly do not look very appealing, with Amazon for instance trading at a staggering 52 times forward earnings estimates. But remember Amazon and Facebook are still a small part of the tech sector, which is far from ‘bubble’ valuations.
Using data from quant analyst Andrew Lapthorne at French bank SG, the global technology sector trades at 10.6 times estimates for profits in 2013 with EPS growth estimated to be 16% for this year.
Focusing on the US part of this industry (the largest by far), and then separating out software/web services from US technology and hardware, the numbers become even more revealing.
US ‘hard’ technology trades at 9.5 times 2013 estimated earnings, with a dividend yield of 2.5%. Ben Rogoff at Polar uses slightly different numbers. He estimates S&P 500 US technology companies currently trade at around 11.5 times forward earnings with a ‘relative PE’( compared to other S&P 500 stocks) of about 0.9.
“This is only the fourth time you have had this differential since 1992,” notes Rogoff. Those relatively unchallenging valuations at an aggregate level are echoed in the balance sheets of the technology sector giants.
Looking again at technology companies within the S&P 500, 30% of the net cash held by the largest companies in the US is in technology firms, compared to just 20% of the market cap.
For Polar’s book of US stocks, Rogoff currently estimates that 12% to 13% of the market caps of his holdings comprise actual, hard cash. Even Apple does not seem over-valued or even faintly bubblish. Whatever one’s views of the giant – and a good bearish argument could be made about mobile phone companies paring back their subsidies for new phones – Apple is still trading at around 10 to 11 times rolling earnings, with cash of $110bn on the balance sheet.
Again, it is worth saying these numbers do not necessarily make Apple a bargain (though it is much cheaper than Amazon by comparison) and there are more than a few reasons why it may lose momentum in the next few years, yet Apple does not look hideously expensive.
So, given a choice between investing in increasingly over-valued government bonds, or sticking your money in depreciating cash, doesn’t it seem a sensible bet to focus on the quality names with strong balance sheets capable of actually producing sustained growth? Step forward the tech leviathans.
David Stevenson is a Financial Times columnist, editor at Portfolio Review and consultant. Follow him on Twitter @advinvestor
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