IT – the fastest growing sector in the developed world
Information technology (IT) stocks continue to benefit from several powerful structural growth trends including cloud computing, cybersecurity, 3D printing and artificial intelligence. Despite the strong past performance, the stocks are still attractively valued.
Whilst we have seen a sharp correction in global information technology (IT) stocks recently, we see this as short term in nature and believe it offers investors an attractive buying opportunity. Not only are these stocks set to benefit from powerful structural growth trends (including cybersecurity, artificial intelligence, cloud computing and 3D printing), but they are also in the perfect position to benefit from the ongoing economic upturn due to high operating leverage – i.e. a very high gross margin relative to costs, and a strong positive correlation of technology spending to gross domestic product growth.
Technology to benefit from rising interest rates
Added to this, the sector is the best positioned to benefit from rising short-term interest rates as a result of its very low financial leverage (i.e. a very low debt ratio). The balance sheet strength in the technology sector can be observed not only in a few large-cap stocks, but also through all IT sub-segments, including software, hardware, internet services and the semiconductor space. Hence, rising interest rates will not negatively affect earnings of the global IT sector and should rather be a tailwind, in contrast to other sectors where leverage tends to be rather high, especially in the U.S.
Capital expenditure expectations have started to rise in the last year and we expect technology spending to increase as a proportion of the overall investment component. Finally, U.S. large-cap technology companies are also expected to be major beneficiaries of President Trump’s repatriation tax.
Relative and absolute valuations look attractive
Despite the strong past performance of global technology stocks, valuations remain attractive if we consider forward price/earnings (P/E) multiples (forward P/E is the price-to-earnings ratio calculated using forecasted earnings). The sector has steadily rerated since 2015 but relative to the broad market, valuations of the IT sector are still slightly below historical averages. In absolute terms, forward P/E multiples of the IT sector are also slightly below historical averages. In light of the sector’s high growth rates, its valuations appear fairly attractive in our view.
While we believe that traditional valuation metrics like P/E remain relevant, some market participants evaluate fast-growing sectors like technology relative to their growth outlook. Based on a price/earnings-to-growth (PEG) ratio of around 1.3x, global technology stocks are also valued at the low end of the market. Against the backdrop of market-leading growth this means there is even more of an opportunity for an upward rerating of the sector.
All these factors support our bullish investment case and underline our ‘Overweight’ rating for global IT stocks. Within IT we maintain our preference for the semiconductor and software sub-segments.