This is the fifth article in the series regarding investing in the information and communications technology (ICT) sector. The earlier articles provided broad overview of various sub-segments of ICT sector and gave some examples of major companies in each. To reiterate, none of the securities or companies mentioned herein is a recommendation to buy or sell, but have been noted for illustration purposes only to make readers aware of major players in both the technology hardware and software categories. Readers are always advised to read the disclaimer at the end of this article.
All investment decisions entail an interplay of risk assessment and return expectations. Here, risk means that at end of the investment time horizon, the investment can lose its original purchase value leading to loss of capital and also, during the investment horizon there can be volatility in the value of the investment (i.e. the value of the investment can be lower or higher than the original investment amount). In this context, potential investors should carefully consider what their risk tolerance is and what their time horizon for investing is. Typically, equity investments, while providing positive returns over longer time horizons (three to five years or more), can and do display volatility in value during shorter time horizons. In the case of information and communications specifically, the volatility in investment value tends to be greater than in several other sectors.
Having said that, recent historic record (five to ten years) indicates that technology sector investments have provided significantly superior returns than the broader stock market - in this case the S&P 500 as the market benchmark (please see the first article in this series for summary of returns for different sectors). It should be remembered that past performance is no assurance of future performance of any investment. At the same time, there are certain secular / mega trends in the global economy which can lead one to conclude that over the next five to seven years, selected sub-segments of the ICT sector are likely to provide returns that are higher than benchmark market index. These trends have been discussed in the previous four articles.
We assume that the reader understands the basics of investing in stock markets, so we will not dwell upon the usual fundamentals of investing. Rather, we want to highlight some important aspects and metrics to keep in mind when thinking about investing in the technology sector and its various sub-segments. It should be noted that this is by no means a comprehensive list of factors that affect the sector as a whole or any of its sub-segments discussed here. Interested investors should conduct their own research and take advice from accredited investment professionals before embarking on their investing journey. With this background, we now turn to the specifics of investing in the ICT sector and its sub-segments.
For the technology sector overall, there are both secular longer-term trends to keep in mind as well as cyclical dynamics. For example, a secular trend is the rise of online shopping, both B2C (business-to-consumer) and B2B (business-to-business) not just in economically advanced countries but also in developing countries. Similar is the case with online banking and payments as well as a host of other activities, including education which are becoming increasingly digitized. This trend is highly likely to continue in the future and the Covid-19 pandemic has simply accelerated it. The greatest beneficiary of this trend is the broader ICT sector and within it, many of the sub-segments that directly and indirectly facilitate online activities which will continue to grow and thrive regardless of shorter-term ebbs and flows of the economic cycles.
In contrast, technology upgrades are driven by obsolescence and innovation that can often be cyclical. Here, investors need to be aware of where in the cycle various segments are - for example, with 5G roll-out beginning in many countries, telecom and component equipment manufacturers are going into a new upgrade cycle, while new applications will become possible which were not so at lower data speeds. This will present both opportunities and challenges for various tech sector sub-segment players. Consider also the case of 'cloud' computing and Software-as-a-Service (SaaS). Five years ago, there was not much uptake in this segment. Today, it is among the fastest growing segments of the technology sector.
As another example, note that one of the characteristics of the software segment is stability of the income stream as customers are locked-in for the long term under licencing agreements. In contrast, the semiconductor segment's earnings are comparatively volatile as these are dependent on capacity additions by chip makers as well advances in chip technology. Consider the recent launch of Apple's latest iPhones and Apple Mac computers, powered by its own designed chips reported to be one of the most advanced processors ever. Apple is shifting from using Intel designed and produced chips to its own designed chips. Apple's A12 Bionic is a 64-bit ARM-based 'system on a chip' (SoC) and is manufactured by TSMC using a 7 nm FinFET process, the first to ship in a consumer product containing 6.9 billion transistors. This move will force other players to shift to newer, more complex and powerful chips and have implications for the semiconductor manufacturers worldwide.
In summary, investors need to understand the dynamics of the technology sector and its sub-segments quite well before moving to specific stocks, which present their own individual fundamentals. These would be related to market share, geographic footprint of customers and revenue, their business model, research as well as innovation history and outlook, and of course revenue growth, cashflow and margins. One of the characteristics of technology investing is that it is driven by growth and not necessary income. So investors in general should be aware that bulk of their returns will accrue in the form of capital gains and not via dividends, which of course implies higher volatility but also the potential for above average returns.
Empirical evidence indicates that the biggest portion of investment return is driven by asset allocation decisions (how much to invest in the overall equity market, how much in various sectors and sub-segments) rather than individual stock selection or market timing decisions. Here we are assuming that interested investors have already made the big asset allocation decision regarding the weight of their investment portfolio that would be in the technology sector.
Given the wide spectrum of companies to choose from and the need to develop deeper understanding of the underlying technology space they operate in, for investors just starting in technology investing, it is preferable to begin with index and ETF investing. This approach allows investors to look at the bigger sectoral picture rather than trying to fathom the intricacies of individual players in the technology space.
Broader Information Technology Sector ETFs
To get the widest exposure to the information and communications technology (ICT) sector as a whole one can take a look at Invesco QQQ Trust (symbol: QQQ), which tracks the performance of the NASDAQ-100 Index. This ETF is heavily tilted towards the technology giants popularly known as FAANGs or FAAMGs (Facebook, Apple, Amazon, Netflix, Microsoft, Alphabet [Google]). The top ten holdings of this huge US$130 billion fund (as of November 20, 2020) include the above companies and constitute 56.5% of total assets under management.
A similar exposure can be had via Vanguard Information Technology Index Fund ETF (symbol: VGT) which has US$39.6 billion of net assets. This ETF has Apple and Microsoft as its two biggest holdings at around 38% of total assets under management. However, beyond these, its focus is on a broader set of bluechips including technology driven payment platforms such as VISA, MasterCard and PayPal, as well as semiconductor hardware players such as NVIDIA, Intel and Cisco and application software companies such as Salesforce.com and Adobe. In all, the top ten holdings of this fund account for over 59% of total assets.
(to be continued)
(The writer is the former Managing Director of Pakistan Stock Exchange and President & CEO of Capital Markets International Advisors, a Toronto, Canada based consultancy. According to him, the companies noted in this article are for information purposes only and used simply as examples. This is not a solicitation to buy or sell any security or company mentioned herein. Except for a small investment (US$4,000/=) in an ETF (IYW), the writer claims he does not own stock in companies noted herein. Forward-looking statements should not be considered as guarantees or predictions of future events. Data provided in the article is from publicly available third-party sources, however its accuracy is not guaranteed and the data should be treated merely as indicative. Anyone interested in finding about investment opportunities should conduct their own research and due diligence within the guidelines of their respective jurisdictions and through authorised investment professionals. Potential interested readers should note that past performance is no assurance of future performance of an investment and the value of any investment may become worth more or less than the original invested amount).
Copyright Business Recorder, 2020