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.

 

RELATED ARTICLES

Why August company reporting season was poor

How we have invested during COVID-19

Dividends, disruption and star performers in FY21 wrap

banner

Most viewed in recent weeks

10 little-known pension traps prove the value of advice

Most people entering retirement do not see a financial adviser, mainly due to cost. It's a major problem because there are small mistakes a retiree can make which are expensive and avoidable if a few tips were known.

Check eligibility for the Commonwealth Seniors Health Card

Eligibility for the Commonwealth Seniors Health Card has no asset test and a relatively high income test. It's worth checking eligibility and the benefits of qualifying to save on the cost of medications.

Hamish Douglass on why the movie hasn’t ended yet

The focus is on Magellan for its investment performance and departure of the CEO, but Douglass says the pandemic, inflation, rising rates and Middle East tensions have not played out. Vindication is always long term.

Start the year right with the 2022 Retiree Checklist

This is our annual checklist of what retirees need to be aware of in 2022. It is a long list of 25 items and not everything will apply to your situation. Run your eye over the benefits and entitlements.

At 98-years-old, Charlie Munger still delivers the one-liners

The Warren Buffett/Charlie Munger partnership is the stuff of legends, but even Charlie admits it is coming to an end ("I'm nearly dead"). He is one of the few people in investing prepared to say what he thinks.

Should I pay off the mortgage or top up my superannuation?

Depending on personal circumstances, it may be time to rethink the bias to paying down housing debt over wealth accumulation in super. Do the sums and ask these four questions to plan for your future.

Latest Updates

Investment strategies

Three ways index investing masks extra risk

There are thousands of different indexes, and they are not all diversified and broadly-based. Watch for concentration risk in sectors and companies, and know the underlying assets in case liquidity is needed.

Investment strategies

Will 2022 be the year for quality companies?

It is easy to feel like an investing genius over the last 10 years, with most asset classes making wonderful gains. But if there's a setback, companies like Reece, ARB, Cochlear, REA Group and CSL will recover best.

Shares

2022 outlook: buy a raincoat but don't put it on yet

In the 11th year of a bull market, near the end of the cycle, some type of correction is likely. Underneath is solid, healthy and underpinned by strong earnings growth, but there's less room for mistakes.

Gold

Time to give up on gold?

In 2021, the gold price failed to sustain its strong rise since 2018, although it recovered after early losses. But where does gold sit in a world of inflation, rising rates and a competitor like Bitcoin?

Investment strategies

Global leaders reveal surprises of 2021, challenges for 2022

In a sentence or two, global experts across many fields are asked to summarise the biggest surprise of 2021, and enduring challenges into 2022. It's a short and sweet view of the changes we are all facing.

Shares

2021 was a standout year for stockmarket listings

In 2021, sharemarket gains supported record levels of capital raisings and IPOs in Australia. The range of deals listed here shows the maturity of the local market in providing equity capital.

Economy

Let 'er rip: how high can debt-to-GDP ratios soar?

Governments and investors have been complacent about the build up of debt, but at some level, a ceiling exists. Are we near yet? Trouble is brewing, especially in the eurozone and emerging countries.

Sponsors

Alliances

© 2022 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.