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Tech shares: Between hope and fear

After the pain of the last quarter, is the sector still worth betting on?

Technology sector equity investors, especially those in funds that are concentrated in tech shares, would love to forget the last quarter of 2018.

Between the beginning of Q3 and the end of Q4, tech investors experienced portfolio drawdowns of between 10 and 30%. Depending on your financial situation and risk outlook, this is either a heart-rending time or a mere eye-twitch moment. You may hope things will improve, or be in fear of permanent loss or missing out on a rally when it comes. Maybe you are somewhere between hope and fear, sitting in no-man’s land. Is there still a positive case to be made for technology?

Read: Here are the momentum tech stocks that defied market’s sell-off

It can be useful to understand the technology universe and the sub sectors within this catch-all classification. Tech as a sector comprises software, hardware, services, networks, infrastructure and content. Tech as term also extends into sectors that create new ways of doing things, such as solar power to generating electricity or robotics to perform surgery. Then there are aspects such as whether Amazon is a tech company or a multi-product and virtually located retailer. Marketing messages and hyped up names such as exchange-traded funds (ETFs) add to the confusion that investors face when making decisions.

Read: Kroger, Microsoft create futuristic grocery store. Amazon, take note

It is therefore important to get a good basic understanding of the term technology and what one is investing in.

Many assume that the Nasdaq market is entirely focused on technology and that only by investing on the Nasdaq can one get access to the best technology investments. But not all listings on the Nasdaq are tech-focused, and tech-focused companies are also listed on other global exchanges. However, the Nasdaq Composite index is used as a proxy for tracking the sector and does capture the sentiment around technology as a sector.

Based on data from www.macrotrends.net

The graph above shows the ratio of the Nasdaq Composite (red line) to the Dow Jones Industrial Average (blue). A high ratio tends to mark periods of extreme bullishness since high-momentum tech stocks attract far more investor funds than more traditional industrial companies as reflected in the DJIA. The red line shows the inflation-adjusted Nasdaq price level. The good news is that the ratio is currently 0.28 compared to 0.46 during the dot-com bust when tech companies were stratospherically valued. The bad news is that the price level is about in line with the peak during the dot-com boom.

The world today – specifically the tech world and its relationship with the real world – is very different compared to the dot-com boom years. It was only around 1999 that rudimentary consumer content started appearing on clunky 2G cellphones in Northern Europe. The dot-com boom was fuelled by the excitement around the potential for e-commerce on computers, which was ahead of its time. In contrast, today’s technology premium rating is around smartphones and their uses for consumers. Today we live our lives predominantly around activities enabled and encouraged on our smartphones.

Investors need to continually remind themselves of humanity’s increasingly rapid dependence on tech today and the resulting effect on the investment thesis.

The graph below shows that in a matter of years rather than decades, more and more people are adopting devices and associated services. Innovative tech companies are constantly introducing new services on these devices and we constantly discover needs we never had 20 years ago.

Source: Visualcapitalist.com

The trend globally is no different as citizens of developing countries increase their internet penetration. At least 2.5 billion more people need to get to internet penetration levels seen in developed markets as the graph below shows. Combined with rising incomes, the increasing number of people adopting technology to enrich their living experience suggests a tremendous opportunity for tech companies to generate wealth for their investors.

Source: World Bank

The macro story for tech as an excellent long-term investment theme seems intact – but based on global trends towards increased adoption rates, is there any value at present in this sector? Since 2015 there has been a lot of press about the sector being in a bubble, and some three years later, by December 2018, this seems to have been borne out.

It seems an opportune time to make certain comparisons with the dot-com era.

Source: Author

The table above compares various shares with snapshot price-earnings ratios between year 2000 and 2018. The current valuations do not seem that frothy in relation to the year 2000. The companies I have listed above in the ‘now’ column are much more mature and represent more of the real economy today. Billions of people use the services and products from these tech companies worldwide. The sector offers excellent long-term value.

Read: Sygnia launches niche funds to capitalise on ‘the future

Pragnesh Desai is CEO of Galileo Asset Managers.

The views and opinions shared in this article belong to their author, cannot be construed as financial advice, and do not necessarily mirror the views and opinions of Moneyweb.

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