Will the tech bubble burst?

9 Oct 2017

Technology stocks are performing well at the moment, but should investors be a little reticent given the infamous dotcom bubble of 1997 to 2001?

Real organic growth

Gerrit Smit, head of equity management at Stonehage Fleming says the difference between the two is that the returns being produced in the technology sector are based on real organic growth that is occurring right now; not on the prospect of future growth, which was the case with dot.com.

Many of the major technology businesses are creating significant free cash flow currently, which is funnelled to shareholders through successful reinvestment or through dividends. “This is an important cornerstone of prudent, successful investing. Without free cash flow, shareholders have more uncertainty of future returns,” he says.

During the dotcom bubble the free cash flow yield on the S&P 500 technology sector was less than 2%. Currently that figure is 4.9%, a ratio of more than double. Furthermore, the 12-month forward P/E multiple in the dot.com bubble era was around 40, whereas now it is 19. “In both instances, the valuations are half as expensive now as they were then.”

In addition to strong free cash flow, Smit sees strong, sustainable, organic growth potential in many technology stocks, notably large-cap counters.

Big data

In the current technology world, the focus is on big data and getting information as fast as possible to as many as possible all over the world through smart mobile devices. While Apple recently launched its new smartphone with a price tag of $999, both India and China are producing models with comparable technology priced around $100. This is making mobile technology and its many benefits accessible to more individuals than ever before, creating a sustainable growth path for well-managed companies that distribute their products through mobile technology.

In the technology sector, the clear way to monitor whether a company remains to be relevant is to follow its organic revenue growth. If this doesn’t come through consistently, it implies that their technology is falling out of favour and the business may be in process of becoming extinct.