This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on July 4 - 10, 2016.
Tech stocks were battered recently and investors are starting to worry that the sector could be looking at its next bust cycle. However, fund managers believe the tech world offers many exciting opportunities.
In the past two years, the global technology sector has enjoyed a bull run almost similar to the dotcom boom of 15 years ago. This year, tech stocks have taken a hit and investors are starting to worry the sector could be seeing its next bust cycle.
However, the prevailing view is that a tech bust is not going to happen anytime soon. In fact, many fund managers believe the sector will continue to provide exciting opportunities.
Devan Linus Rajadurai, founder and chief investment officer of Malayan Traders Capital, for one, does not see a bubble forming in the US tech sector. He believes it is a good time for investors to buy “legacy and established” tech companies such as Apple and Microsoft. Legacy companies, he says, are those whose products and services are already a part of people’s lives, such as Apple’s iPhone, Google’s search engine and Intel’s chips.
Malayan Traders Capital’s Absolute Return Fund has about RM100 million under management, 41% of which is invested in global tech companies. As at May 12, the fund — which is domiciled in the Cayman Islands — had generated a return of 44.4% since its inception in June 2012.
Indeed, in the last two years, companies such as Apple and Microsoft had seen their stock prices increase by more than 60% while new tech firms such as Netflix and LinkedIn were trading at PERs of more than 100 times.
However, things changed early this year. Netflix’s shares plunged 23% in January while LinkedIn’s shares fell almost 50% on Feb 4 alone.
In April, Apple and Microsoft saw their share prices drop 17% and 10% respectively after posting disappointing quarterly results. Alphabet, the parent company of Google, also saw its share price decline as earnings came in below market expectations.
“There has been a huge overvaluation of social media or ‘web-based’ companies such as LinkedIn and Netflix. LinkedIn was loss-making and the shares were trading at a high price before they crashed. The company was acquired by Microsoft on June 13,” says Devan.
“Investors of unlisted companies such as Uber and Evernote are largely private venture capital firms. And if you look at the total assets of these firms, the number is small relative to the whole asset management industry. So, if these few companies go bust, it will not affect the global market.”
Netflix was trading at a PER of 316.07 times on the Nasdaq as at June 24, according to Bloomberg data. LinkedIn was trading at a PER of 1,189.5 times last year and its estimated PER for this year is 906.29 times. The average PER of the Nasdaq Composite Index was 29.53 times as at June 26.
Grant Bowers, vice-president and portfolio manager of the Franklin US Opportunities Fund, a feeder fund launched in Malaysia, does not expect a bubble to form in the US tech sector either. “We don’t see a bubble forming. We hold a long-term and positive outlook for the sector,” he says.
The Franklin US Opportunities Fund feeds into a target fund of the same name. According to the feeder fund’s fact sheet as at April 30, four of its top 10 holdings were tech stocks — Alphabet, Facebook, Amazon and Apple.
Positive Long-term Outlook
Bowers says now is a good time to invest in US tech companies with high quality growth, superior profitability and meaningful competitive advantages, with the right valuation. The growth in the tech sector is expected to be driven by companies’ continued investment in technological improvements to remain competitive.
“Despite this year’s pullback, we still have a positive long-term outlook for tech companies as the growth outlook remains strong, with a tremendous amount of changes likely to take place in the next few years. The tech sector has always experienced bouts of volatility. But historically, these events have been excellent buying opportunities for investors,” he says.
“The outlook remains because companies’ spending [on technology] remains strong as many have realised that investment in technological improvements are required to remain competitive in the global marketplace. New software, factory automation and data analytics can all improve productivity and lower production cost for companies, thus keeping them ahead of their competitions.”
The Franklin US Opportunities Fund has generated a return of 26.24% since its launch in May 2013. However, it had posted a return of -7.33% in the 12 months ended April 30. Alphabet and Facebook were its top two holdings at 4.53% and 4.28% respectively.
“Alphabet is the world’s leading search engine and the largest beneficiary of the ongoing shift from traditional to digital advertising. Facebook is the world’s largest social media company with more than 1.6 billion monthly users worldwide. The Facebook network is scalable and growing rapidly. It will continue to monetise its large user base in the years ahead,” says Bowers.
Devan says the plunge in share prices has presented investors with a good opportunity to buy into tech companies such as Apple and Microsoft. These companies have strong balance sheets and cash flow and will continue to generate profits by selling smartphones in emerging markets such as China, India and Indonesia, he adds.
Meanwhile, an analyst with a local fund management firm who covers technology stocks says he does not see much upside for the global tech sector going forward. That is because companies are already cutting their supply of smartphones as demand has reached a peak this year.
“The tech sector has had a bull run in the past two years and there is an oversupply situation in terms of hardware, especially smartphones. The market is saturated and the big boys are cutting down on their supply,” he explains.
But Devan does not think so. He believes that despite the saturated smartphone market, sales could expand further on the back of untapped demand from emerging markets such as China, India and Indonesia.
The analyst points out that sales of hardware such as personal computers have also dropped in recent years. “The demand in the hardware space has slowed and I do not see many catalysts in the short term. Virtual reality and electric vehicles can be the new catalysts for the industry, but over the long term.”
However, Devan says the overall tech sector, which includes software products and web-based services, is actually seeing growth. “If you look at the revenue generated by major tech companies around the world, it is growing.”
Cloud computing the next growth catalyst
One of the things that will boost the earnings of technology companies, says Devan, is the rising demand for cloud computing technology, which allows users to store and access data on the internet.
“Cloud businesses, which provide data storage services and online server capacity, are growing at more than 20% per annum. That is one reason Microsoft is still doing well,” he says.
Devan is referring to the Worldwide Semi-annual Public Cloud Services Spending Guide produced by International Data Corp, a US-based market research, analysis and advisory firm that specialises in IT. It projects worldwide spending on public cloud services to grow at a compound annual growth rate of 19.4% over the next four years.
The higher demand for cloud computing solutions can be seen in the profits generated by Microsoft’s cloud products Azure and Office 365. Another indicator of the huge potential of the cloud is the services provided by Amazon Web Services Inc (a subsidiary of Amazon.com), which saw a revenue of US$7.88 billion in 4Q2015, up 69% from the previous corresponding period, based on its recent earnings report.
Apple is one of Devan’s favourite stocks. It was trading at US$96.10 per share, with a PER of 10.74 times, on June 24. The share price had fallen dramatically since the company’s quarterly results were announced on April 26.
Apple’s revenue had fallen for the first time in 13 years as iPhone sales declined for the first time ever. Two days after the results announcement, billionaire investor Carl Icahn sold his stake in the company after expressing his concerns over the attitude of the China government, which could make iPhone sales “very difficult”. Apple shares subsequently dropped 9.12% to US$94.26 per share.
Devan says the stock is looking attractive as Apple is sitting on US$200 billion cash while generating US$40 billion every year. “The company has a market capitalisation of US$500 billion. It has US$200 billion on its books and every year, it makes US$40 billion cash. This shows it is a good investment and that is why Berkshire Hathaway bought into it. It knows the market sometimes does not understand tech stocks.”
He says one of the reasons iPhone sales have been affected is because Chinese consumers are holding back on the purchase of the current model and are waiting for the iPhone 7, which is expected to be launched later this year. “While waiting for that to come out, they are buying the cheaper Huawei or Oppo smartphones. When the iPhone 7 comes out, Apple’s earnings will increase. I am sure that the smartphone will be big in China as the consumers there like highly innovative products.”
The company, meanwhile, has rolled out the cheaper iPhone SE targeted at the emerging markets.
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