Digital Drivers

The technology sector has great potential for disruption, but the path towards progress is not always smooth.

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Technology companies operate in a fast-paced industry with many opportunities, but also face considerable pressure to continuously innovate and stay ahead of the curve. Despite the recent outperformance of stocks in this sector, the segment has experienced a volatile few years. Given this trend, investors could be well served to be wary of rapid gains, as it’s clear they can also be rapidly reversed. 

Rather than focusing on cash flows and profitability in the early stage, technology firms often first aim to capture market share. However, they are still sensitive to general economic conditions and rising interest rates have challenged this model, with there now being greater pressure to increase revenues. While these stocks can have high levels of capital growth, they’re not the best option for investors looking for regular dividends and tend to reinvest earnings into the business.

Salesforce ($CRM)

The company tracking customer interactions and sales data saw the year-on-year (yoy) total revenue grow by US$34.9b, around 11%, in the Q4 FY 2024 ending on 31 January. Subscriptions and support services accounted for the vast majority of revenues, approximately 94% during his period and the remaining amounts came from professional services. The last area has seen a slowdown amidst weaker economic conditions, declining 9% in the quarter. 

Investors should keep in mind that this trend is likely to continue, as Salesforce expects future financials to be impacted by currency fluctuations and a lower demand for professional services. They’ve put forward guidance of earnings per share of US$9.68 to US$9.76 and annual revenues of US$37.7b to $38.0b for the upcoming fiscal year, which would be equivalent to 8.6% growth. The company expects artificial intelligence (AI) to contribute to internal margins, but not be a significant factor in overall revenues. 

Palo Alto Networks ($PANW)

The cybersecurity firm achieved its eighth consecutive quarter of expanding margins in Q2 FY 2024 ending on 31 January. Revenues grew 19% to US$1.98b and earnings per share increased 39% to US$1.46. The business has been consolidating its offerings to focus on platforms, where users can access a bundle of services. This move would differentiate it from competitors, but would also involve trying to convince clients to use the whole Palo Alto portfolio rather than a selection of products. 

This move has raised some concerns amongst investors, as the CEO mentioned ‘spending fatigue’ amongst customers in the latest earnings call. Total billings guidance was also lowered from the range of US$10.7b to US$10.8b to US$10.1b and US$10.2b. Investors interested in gaining exposure to the cybersecurity sector might also consider CrowdStrike ($CRWD), which won several recent contracts over rivals. While there is a clear need for greater data security as a longer term trend, not all businesses in the area will outperform the market. 

Amphenol Corporation ($APH)

As one of the world’s largest designers and makers of interconnectors, antennas and other electrical components for various end products, the company exceeded its sales targets for Q4 FY2023 ending on 31 December. As the firm caters towards a range of customers its earnings can be insulated from a downturn in any single segment. However, investors should consider that the share price won’t experience the same highs as those from more concentrated businesses, as seen with the recent optimism around AI related stocks. 

Amphenol is expanding its reach through acquisitions, with ten in FY 2023, and recently bought the Interconnect Technologies segment of Carlisle Companies ($CSL) for US$2.025b in cash. These are significant sums compared to annual sales, which totalling US$12.55b in FY 2023 and not integrating the new assets quickly could lead to disruptions in cash flows. However, as a relatively mature and diversified business, Amphenol did return around US$1.1b to shareholders in the last fiscal year. 

Innovation plays

There are several ETF options for investors who want to invest in the information technology sector generally, rather than looking for a specific stock. 

The Technology Select Sector SPDR ($XLK) has a fee of 0.09% and focuses on tech firms in the S&P 500 index. The Vanguard Information Technology ETF ($VGT) covers a broader range of firms, having 312 holdings as of 31 January compared to 64 in $XLK. However, both of these ETFs tend to be rather top heavy and have weightings of over 20% to Microsoft ($MSFT). Investors concerned about the impact of a single firm on the sector, such as the recent exceptional growth by Nvidia ($NVDA), can consider the Invesco S&P 500 Equal Weight Technology ETF ($RSPT) instead. The weighting of its holdings are adjusted to all be equal, rather than reflect their size by market cap.

The NASDAQ index is largely associated with the technology sector, including stocks which are officially classified in other segments, such as Amazon ($AMZN) which falls into the consumer discretionary group. The Invesco QQQ Trust ($QQQ) and Invesco NASDAQ 100 ETF ($QQQM) are two ETFs tracking the NASDAQ 100 index with considerable assets under management, although the latter has a 0.05% lower fee for cost conscious investors. This article could be useful for those interested in additional products related to this index.  

There are also a number of ETFs available for investors looking to gain exposure to a specific subsector. The iShares Semiconductor ETF ($SOXX) is a popular choice amongst Stake investors who are bullish about the future of chips, while the First Trust Nasdaq Cybersecurity ETF ($CIBR) could be of interest to those concerned about cyber attacks. 

Global X Cloud Computing ETF ($CLOU) covers another segment that could experience significant demand due to increased digitisation. Gaining exposure to tech firms outside the U.S. is more challenging for investors, with even the iShares Global Tech ETF ($IXN) having just under 80% of its holdings listed in the nation. Selecting specific stocks could be a better approach for investors interested in this area.


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