The astonishing performance of Twitter’s shares following its recent IPO made headlines around the world. The shares rose 72% on their first day of trading and the company now has a market value of around US$26 billion – all for a company that was launched as recently as 2006 and isn’t making a profit.
For many this has brought back memories of the technology bubble of the late 1990s, when it seemed like any computer programmer with a business plan written on the back of an envelope could attract a billion dollar valuation. The growth of the then fledgling World Wide Web saw the technology index quadruple between October 1998 and March 2000, before collapsing to less than a fifth of their peak by 2002. But is Twitter’s valuation a sign that we’re in a new bubble?
Technology has moved on since 2000, and so has technology investing. Apple is now the largest company in the world by market valuation, with a customer base that stretches far beyond hard core geeks. Amongst the other largest technology companies are Microsoft and Intel, which supply the software and chips for most PCs and are used in offices and homes around the world. Google has expanded from online search specialists to a technology conglomerate which dominates the mobile market via Android. Even the less familiar names in the technology index are part of our everyday lives - chipmaker Qualcomm supplies the innards of many of our mobile phones, whilst Cisco provides the routers and switches that are the plumbing of the internet.
All told the technology sector makes up 12% of global stock markets, making it larger than both the healthcare (10%) and oil & gas (9%) sectors. This actually understates the importance of technology companies - internet retailers like Amazon and eBay and electronics companies like Sony are classified as consumer stocks and don’t feature in the technology index. Tech companies are now part of the mainstream.
One of the most common ways of judging company valuations is by looking at the forward price earnings ratio (PE). Essentially this compares companies’ market valuations to their forecast profits – the higher the PE, the more expensive the company. The Datastream Technology index is currently trading on a forward PE of 15.3. This isn’t much higher than the PE for markets globally of 13.8, and well below its 20 year average of 21.3. The technology sector doesn’t look expensive compared to either the rest of the stock market or to history.
This partly reflects the age of many of these companies. Whilst the dotcom boom was dominated by companies with short track records, the current index is dominated by more mature names. Of the top 10 largest tech companies, Google (formed 1999) is the newest. Apple and Microsoft were formed in the 1970s, Intel dates back to 1968 and IBM celebrated its 100th birthday in 2011. As large, mature businesses they are unlikely to grow as fast as smaller, emerging businesses and perhaps deserve lower valuations. However, the technology index is 49% below the peak it reached in 2000.
Social networks – the new bubble?
That’s not to say that certain stocks or sectors of the market might not be overvalued. Social networking is a key example. There is even an ETF listed on the New York Stock Exchange that invests solely in social networking companies. Its portfolio includes Facebook, currently trading on a forward PE of 44, and LinkedIn which is on a stratospheric 99 – these compare to a peak forward PE of 54 for the technology index in 2000.
Facebook is now a $100bn company having been formed less than 10 years ago, but will need to grow profits quickly to justify this valuation. With over a billion users it doesn’t seem likely to go away anytime soon. However, MySpace was the dominant social network as recently as 2009 and already some teenagers are shunning Facebook for more youth-centric offerings like Tumblr and Snapchat.
Given the size of the sector, technology shares feature in many funds, particularly those with exposure to the US, which continues to dominate the industry. Examples of US funds include our three-star rated HSBC American Index, which has 15% exposure to technology and our five-star rated Legg Mason US Smaller Companies, which has 19% exposure. In the UK, Liontrust Special Situations, which we rate five stars, has 15% exposure to technology.
Investors looking for specialist technology exposure could consider the GAM Star Technology fund or the Polar Capital Technology investment trust, both strong performers in recent years, whilst the Herald Investment Trust (rated four stars) specialises in small cap tech companies that could become the Apples and Googles of the future. As the decline of Nokia and Blackberry shows, in the world of technology winners can fast turn into losers, so buying individual stocks is best left to the experts.