Techinvest Comments on Technology Stocks

The latest edition of the Techinvest newsletter has just been issued. This is a newsletter that comments on smaller cap UK technology stocks and is always worth reading for those who hold such shares as I do. The latest editorial is particularly worth reading in my opinion. I quote from some of it below.

“Between 1994 and 2000. the gain on the Nasdaq index was circa 590%. It subsequently lost around 76% of its peak value in the tech stock crash that played out over the next three years.

As we have commented before, however, we doubt that the bear market this time will follow the path taken during the unwinding of the bubble. For one thing, current tech stock valuations are not as stretched as they were back then. Also, tech is a much more established part of the economy today, benefiting from developments such as digitisation, automation, and cloud services upon which modern enterprises are increasingly reliant. The crash was driven primarily by realisation among investors that a speculative bubble had formed in tech stock prices. By comparison, tech stocks are selling off today in response to concerns about events in the real world, chiefly supply chain shortages and rising inflation. Fears of a looming recession in particular has dented risk appetite and made investors cautious about backing growth stocks at a time when the outlook for the economy is turning down. Investors are also showing preference for safe haven blue-chip stocks at the expense of the smaller cap sector. Unfortunately, most tech companies with a London-listing are small cap and have suffered accordingly due to their perceived lack of defensive qualities relative to larger cap brethren in old economy sectors.

Given that most tech operators continue to report strong results and appear to be absorbing the impact of supply shortages and rising operating costs reasonably well, the current sell-off may seem irrational. But markets look ahead and try to discount events that appear likely to occur in the medium term. A worsening economic situation later this year and into 2023 does seem likely and therefore needs to be discounted in current stock prices. Whether this justifies the heavy falls seen in tech stock prices, however, is questionable. After all, tech would seem to have the wherewithal to come through a downturn in better shape than many other parts of the economy. Balance sheets are generally strong in the tech sector and many operators have good cash generation and high levels of reliable recurring revenue. Secular growth trends, such as automation and digitisation, also provide a strong underpinning for tech demand even if IT budgets become more constrained in a downturn. While we recognise some justification on economic grounds for the sharp de-rating of tech stocks since last year, we also feel there is an element of overreaction driven by fear and short- termism. Good stocks have been pulled down alongside ones that have weaker fundamentals, creating some attractive buying opportunities”.

Comment: As the editor points out private equity investors are pouncing on good opportunities in the UK – EMIS and Ideagen are examples of recent bids at very substantial premiums. If a recession does come, those technology businesses with high recurring revenue and good balance sheets may not suffer much. Once a customer has become reliant on technology they will rarely ditch it or change suppliers. So they can be very defensive stocks to own. The ones to avoid are those with no profits, poor cash flow and reliance on future fund raisings which may not be forthcoming in a recession.

Roger Lawson (Twitter:  )

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