The Outlook for Tech Investing

Sector Performance & Fundamentals

• Technology has outperformed all other sectors during the current crisis, driven by superior fundamentals compared to the broader market.
• S&P 500 earnings estimates have declined roughly 20% overall, whereas the tech sector has seen a decline of only 7%.
• Tech performance is attributed to higher resilience in earnings and revenue as consumers increased at-home spending and corporations adopted agile work environments.
• Tech companies are inherently more defensive due to strong balance sheets characterized by net cash positions rather than the debt leverage found in other sectors.

Business Model Shifts

• Over the last five years, tech firms have aggressively transitioned to recurring business models, providing increased visibility for investors.
• Historically, returns concentrated in U.S. mega-cap stocks, but innovation is now expanding into emerging markets and smaller U.S. market caps.

Emerging Opportunities

• Emerging markets are developing local e-commerce giants (e.g., potential next Amazon, PayPal, Netflix equivalents) driven by first-time access to ubiquitous LTE and smartphones.
• The U.S. public cloud is fostering new SaaS companies that disrupt legacy technologies, improving employee productivity at significantly lower costs.

Investment Strategy Framework

• Research categorizes tech investments into three buckets, with primary focus on the second and third:
  • Unsustainable beneficiaries: Companies like video conferencing and PC hardware seeing temporary demand spikes that may normalize.
  • Sustainable beneficiaries: SaaS and payments firms where cyclically depressed fundamentals mask accelerated subscriber acquisition rates (e.g., 2.5x historical rates).
  • Cyclically depressed areas: Companies serving SMEs or selling into autos/semiconductors; these are expected to see strong rebounds as the environment normalizes.

Risk Factors

• Regulatory: U.S. regulatory rhetoric is expected to increase approaching elections; Europe has enacted regulations targeting monopolistic behavior and raising taxes, which could pressure mega-cap tech earnings.
• Supply Chain & Margins: U.S.-China trade tensions are shifting supply chain priorities from cost optimization to availability, likely resulting in lower future margins for tech companies.
• Valuations: While some pockets face extreme valuations due to unsustainable fundamentals, the broader tech sector trades at a 10% premium to the rest of the market, a discount compared to the 20% premium seen over the last two decades.