U.S. giants dominate the sector but some interesting UK-based prospects are on the rise.
Sector in focus: Technology
The strength of many large technology stocks so far this year has attracted a lot of attention from both investors and the media. It must be said that not all the coverage in the press has been exactly favourable with Facebook in particular suffering bad publicity due to its links with the now defunct data analysis group Cambridge Analytica. It is part of the high profile FAANG group which also includes Google, Amazon, Netflix and Apple.
Those stocks cover a wide range of products and services. While their individual performances have varied considerably in recent times the information technology sector of the S&P 500 posted a remarkable 38% return in 2017. Indeed, the performance has been strong over at least the last five years with technology stocks responsible for almost 30% of the total gains of the S&P 500.
The combined performance of the FAANG companies in the year to date has been such that the US market would have fallen overall if it were not for them. The sheer size of these giants is underlined by the fact that two of them are now approaching the $1trillion valuation level while their combined value is now more than the entire FTSE 100 index.
Naturally the question that arises from all this is whether that performance can possibly continue. A big part of the answer to that can be found in our daily lives. Technology is continually extending into new areas such as autonomous cars, healthcare and banking with advances also seen in robotics and artificial intelligence.
High speed internet connections are becoming more common with 4G, and soon 5G, Wi-Fi benefiting smartphone users. That in turn is helping drive consumer demand for new connected household devices, the fabled “internet of things”, and enabling more people to stream video and services such as Netflix.
Of course, those who can remember the dotcom bubble will naturally be wary of being overexposed to this sector and sceptical of ambitious claims by companies about their potential. In general it is a sector more suited for long-term investors seeking capital growth and willing to accept a medium to higher level of risk. The sector tends to be dominated by many smaller companies that are growing and therefore little is offered by the way of yield and therefore not attractive to income seekers.
A notable feature of the sector is the huge variety of software services and IT solutions provided which means that companies are not necessarily competing against one another but rather developing a niche segment for themselves.
Balance sheets appear strong, with many established companies boasting large cash balances and relatively low debt. Prospects remain positive in 2018 with a supportive macroeconomic environment and the potential boost from President Trump's recent tax legislation. The repatriation of cash back to the U.S at favourable rates should encourage share buybacks and increase mergers and acquisitions.
In geographic terms the sector is heavily tilted towards the US and Asia. Sage and Micro Focus International are the only representatives from this sector in the FTSE 100. Micro Focus produces software which helps its customers, mostly large companies, to improve the efficiency of their IT systems and helps them integrate new software applications with older ones.
It has seen some turbulent times recently with the performance of software assets acquired from Hewlett Packard not meeting expectations and some unexpected management changes.
All of that has unsettled the market and led to a sharp fall in the shares but revenue guidance in May from the company was more positive and the dividend yield of 6.7% is appealing. While the fall in the shares looks overdone and there's a chance that the company may yet see some benefit from the Hewlett Packard assets, the shares are no more than a hold for medium to higher risk investors.
Sage is best known for providing accounting and payroll software to small and medium-sized businesses. It is seen as a fairly defensive business but investors were shaken by results in April which showed a drop in first half revenue growth from 7.4% to 6.3% due to a slowdown in recurring revenue growth and "contract licence slippage".
Sage’s management believe in a "golden triangle" of accounting, people and payroll with payments and banking reinforced by cloud computing, but the profits warning and reduced growth expectations make this stock no better than a hold.
On the subject of the cloud, one of the most interesting parts of the technology sector at present, we like AIM-listed Iomart. It is one of the UK's leading companies in an industry that is expected to grow fairly rapidly as companies and consumers generate more data and become comfortable with having that data located offsite. It is able to provide a more niche service to its clients than the global giants such as Google, Amazon and Microsoft. A large portion of the revenues are recurring and profit margins are high. The shares have made steady progress over recent years and with good long term prospects and rising dividends we continue with our buy recommendation for investors looking for capital growth and willing to accept a higher level of risk.
In a totally different part of the technology sector is Amino Technology. Also AIM-listed the company produces hardware and software products designed to enable broadband providers to offer television and other services to consumers. It has customers in many countries around the world, both developed and emerging, and targets sectors including the hotel and hospitality industry. It should benefit from the trend towards internet protocol television services, which include things such as catch-up TV and video on demand. The dividend yield is unusually good for the sector at 4.0% but we view the shares as a buy for higher risk investors.
In conclusion, many of the well-known and high profile tech stocks may have soared in recent times and dominate the headlines, but there are plenty of smaller companies for investors to consider which have compelling stories and good growth potential.
All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.