Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 382

Why tech companies trade at a premium

Compared to the US, where technology stocks are now the largest sector of the S&P500 at 27% of the index, Australia has a small tech component. Despite this, Australian businesses also face significant tech disruption, often by companies not traditionally associated with ‘tech’, such as Steadfast (ASX:SDF), James Hardie (ASX:JHX), CSL (ASX:CSL), Resmed (ASX:RMD) and REA Group (ASX:REA).

Many companies are using tech to disrupt competitors, and with intellectual property investment only 2% of Australia’s GDP compared to 5% in the US, as shown in Figure 1, tech disruption has barely started on a long journey.

Figure 1: IP investment remains much lower in Australia than in the United States

An innovative way to measure tech disruption

Equity analysts at UBS Securities in Australia embarked on innovative research to measure tech disruption. They were asked to rate which stocks are most effective in using data and technology relative to peers in their sector. They also checked which stocks use tech phrases in their stock exchange updates, including references to artificial intelligence, machine learning, natural language, deep learning and predictive analysis. UBS reports:

"Appen, Telstra, Insurance Australia Group, PRO Medicus, Seek, ASX, Flight Centre, QBE Insurance and Xero mentioned these phrases at least 100 times over the past five years."

Overall, they found that stocks identified as tech focused had Price/Earnings ratios (P/Es) that were significantly higher than their peers. UBS then back-tested to show that stocks with high tech disruption scores outperformed stocks with low disruption scores by an annualised 14% since the start of 2016.

Table 1 shows the identified companies and their tech disruption and tech mention scores. 

Table 1: Key growth names

Tech stocks which UBS likes include Appen, NextDC, Nanosonics, and REA. Non-tech stocks with a high-tech disruption score or lagging share prices include Aristocrat Leisure, CSL, ResMed, James Hardie, Breville and Steadfast Group. UBS thinks Altium and Magellan are worth watching, all listed above.

Tech disruption explains Growth outperforming Value

UBS also finds that tech disruption is contributing to the ongoing outperformance of Growth over Value stocks, which is a major issue for fund managers who have built their businesses on identifying 'Value' (or companies trading at below their fundamental values). The increase in the valuation gap between high and low PE stocks has, in part, been justified by high PE stocks producing significantly higher earnings growth than their low PE counterparts, as shown in Figure 2. Tech companies are usually Growth stocks.

Figure 2: Earnings of ASX200 growth stocks versus value stocks since 2007

Since the start of 2007, earnings of growth firms have nearly doubled, while earnings of value stocks have halved. The high growth firms justify higher multiples due to their higher earnings growth. The earnings of tech disrupters have also consistently grown faster than tech laggards since 2016 (Figure 3).

Figure 3: Tech disrupters EPS relative to tech laggards

Tech disruptors are Growth stocks and benefit from lower rates

UBS has also written notes on how ultra-low rates are having a major impact on the prices of Australian equities:

"An additional insight from those notes is that a lower risk-free rate means that long-dated future cash flows matter more than near-term cash flows in a discounted cash-flow framework. Put differently, the terminal value component accounts for a greater proportion of the value of the equity. Growth stocks are longer duration assets (more cash flows in the future). Value stocks are shorter duration assets (less cash flows in the future).

Tech disruptors are Growth stocks and therefore benefit from lower rates due to their duration. Lower rates also mean that tech disruptors are able to finance technology at lower cost and take a longer-term view on tech-related projects. Lower overall market EPS growth is also positive for tech disruptors and other Growth stocks due to the scarcity premium that they command."

Figure 4 highlights the decade of Growth outperforming Value.

Figure 4: Growth outperforming Value since the GFC

 

In a note of optimism that investing is not only a tech story, UBS also notes:

"High quality industrials that are able to maintain solid earnings growth in a low interest rate environment are likely to outperform." 

The market is also seeing larger stock-specific price reactions to news events, as so much of the price is determined by long-term expectations. Either a threat to or affirmation of this future potential sends investors to buy and sell and the market catches the momentum. The potential for long-term durable competitive advantages is especially valued.

 

Graham Hand is Managing Editor of Firstlinks. This article draws on the work of Pieter Stoltz, Jim Xu and Paul Winter, Equity Analysts at UBS Securities. This article contains general information only and does not constitute personal financial product advice. It does not consider any investor’s objectives, financial situation or needs.

More articles and papers from UBS, a sponsor of Firstlinks, can be found here.

 

UBS

RELATED ARTICLES

Why August company reporting season was poor

How we have invested during COVID-19

It’s the large stocks driving fund misery

banner

Most viewed in recent weeks

Three steps to planning your spending in retirement

What happens when a superannuation expert sets up his own retirement portfolio using decades of knowledge? He finds he can afford much more investment risk in his portfolio than conventional thinking suggests.

Finding sustainable dividend stocks on the ASX

There is a small universe of companies on the ASX which are reliable dividend payers over five years, are fairly valued and are classified as ‘negligible’ or ‘low’ on both ESG risk and carbon risk.

Retirement income promise relies on spending capital

The Government has taken the next step towards encouraging retirees to live off their capital, and from 1 July 2022 will require super funds - even SMSFs - to address retirement income and protect longevity risk.

Among key trends in Australian banks, one factor stands out

The Big Four banks look similar but they are at fundamentally different stages as they move to simpler business models. Amid challenges from operating systems, loan growth and neobank threats, one factor stands tall.

Why mega-tech growth are the best ‘value’ stocks in the market

They are six of the greatest businesses ever and should form part of the global portfolios of all investors. The market sees risk in inflation and valuations but the companies are positioned for outstanding growth.

How to manage the run down in your income in retirement

The first of five articles on modern retirement income products that aim for an increasing pension that lasts for life and on average should not decline in real terms. They are not silver bullets but worth a look.

Latest Updates

Superannuation

Retirement income promise relies on spending capital

The Government has taken the next step towards encouraging retirees to live off their capital, and from 1 July 2022 will require super funds - even SMSFs - to address retirement income and protect longevity risk.

Superannuation

How retirees might find a retirement solution in future

Superannuation funds need to establish a framework that offers retirees a retirement income solution that lasts a lifetime. It will challenge trustees to find a way to engage that their members understand and trust.

Investment strategies

Dividend investors, your turn is coming

Dividend payments from listed companies, depended on by many in retirement, have lagged the rebound in share prices over the past year. Better times are ahead but sources of dividends will differ from previous years.

Investment strategies

Four tips to catch the next 10-bagger in early-stage growth

Small cap investors face less mature companies with zero profit that need significant capital for growth. Without years of financial data to rely on, investors must employ creative ways to value companies.

Investment strategies

Investing in Japan: ready for an Olympic revival?

All eyes are on Japan and the opportunity to win for competing athletes. After disappointing investors for many years, Japan is also in focus for its value, diversification and the safe haven status of its currency.

Fixed interest

Five lessons for bond investors from the Virgin collapse

The collapse of Virgin Australia not only hit shareholders, but their bond investors received between 9 and 13 cents in the $1. A widely-diversified portfolio can tolerate losses better than a concentrated one.

Investment strategies

The 60:40 portfolio ... if no longer appropriate, then what is?

The traditional 60/40 portfolio might deliver only 1.5% above inflation in future without diversification benefits. Knowing an asset’s attributes rather than arbitrary definitions is better for investors.

Retirement

Two factors that can transform retirement investing

Retirees want better returns but they have limited appetite to dial up their risk exposure in order to achieve it. Financial advice and protection strategies in portfolios can enhance investment outcomes.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.